US Equity Indexes: Short-Term Volatility Expected Due to Rate Cut Uncertainty

While some wait for a recession, others are watching for a potential jump in inflation that could derail any thoughts of future rate cuts by the Fed.
James Hyerczyk
U.S. Equity Markets

The major U.S. Stock indexes closed lower last week after posting three straight weeks of solid gains. Early in the week, the markets were driven lower by a spike in oil prices, but by mid-week, conditions stabilized following the release of the Federal Reserve’s interest rate and monetary policy decisions.

Last week in the cash market, the benchmark S&P 500 Index settled at 2992.07, down 0.50%. It’s up 19.4% for the year. The blue chip Dow Jones Industrial Average finished at 26,935.07, down 1.00%. It’s up 15.5% for the year and the technology-based NASDAQ-Composite Index closed at 8117.67, down 0.70%. In 2019, it’s up 22.3%.

Stocks spiked lower last Monday after an attack on a major oil production facility in Saudi Arabia took out about 6% of the world’s production. Crude oil initially surged 15% on the news, but gave back most of those gains before settling about 6% higher for the week after Saudi officials said production would be back to normal by the end of the month, sooner than traders feared. Energy shares followed the same movement as crude oil with traders still leaning toward the upside due to potential risks from a repair slowdown and additional attacks on Saudi infrastructure.

As far as monetary policy is concerned, the Federal Reserve cut its federal funds rate by 25-basis points as widely expected as policymakers sought to insure the economy against risks from slower global economic growth and uncertainties over U.S.-China trade relations. The Fed’s decision to cut rates was not unanimous with two Federal Open Market Committee (FOMC) members voting against the move and one calling for a 50-basis point rate cut.

The Fed was also unclear about the need for future rate cuts due to the healthy economy. At the end of the week, investors were downplaying the chances of an October rate cut, but a December rate cut was still in play.

Stock market investors are enjoying favorable times with the economy seemingly healthy and the Fed cutting rates twice this year, and maybe a third time to insure the continuation of the economic expansion.

For starters, unemployment is at 3.7%, one-tenth of a percent from its lowest level in 50 years. The 107 consecutive months of jobs growth is the longest streak on record and wages are rising at an average of 3.2% so far this year, the strongest move in more than 10 years.

Personal spending is also up by an average of 3% since the fourth quarter of 2017. US. GDP growth has averaged 2.7% over the past two years. This could be better, but it’s not on the edge of recession like many were predicting a month ago.

Essentially, the economy is in decent shape and could get better with the rate cuts. This is potentially bullish for the stock market. However, we’re likely to see volatility over the short-run because of the uncertainty over future rate cuts, pockets of weakness within the economy and worries over U.S.-China trade relations. Furthermore, while some wait for a recession, others are watching for a potential jump in inflation that could derail any thoughts of future rate cuts by the Fed.

The stock market could do well into the end of the year if equities rise because of expectations of strong earnings growth. However, if the rally is being driven by rate cut expectations then it will be susceptible to volatile price swings if rising inflation forces the Fed to hold policy steady.

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