Investors have set their hopes on a big cut in interest rates, an expectation that gave new life to the stock market’s rally and shows how pivotal the Federal Reserve’s decision on Wednesday will be to sentiment in the financial markets.
The S&P 500 rose for the seventh straight day on Tuesday, bolstered by economic data and rising expectations that the Fed will cut rates by half of a percentage point, double the typical quarter-point adjustment the central bank typically makes. The rally has left the index just 0.6 percent from surpassing its record high set in July.
The Nasdaq Composite index, which is chock-full of tech stocks deemed to be among the most sensitive companies to rate changes, has climbed over 5 percent since early September and sits about 5 percent below its July peak. The Russell 2000 index of smaller companies has also moved more than 5 percent higher over the same period, leaving it less than 3 percent away from its July record.
The gains have come with traders in futures markets indicating that they think a half-point cut — even if an unusually big move — is the most likely outcome on Wednesday. That’s a big shift in thinking from just a few weeks ago.
Lower rates (all else being equal) would be supportive to the stock market, easing borrowing costs for companies and increasing the value of investors’ holdings.
But it also matters why rates are being cut. If the Fed is cutting rates aggressively because policymakers are worried about the economy, stock prices are likely to slide. Right now, the hope among investors seems to be that the Fed will act fast so it can stay ahead of any potential economic weakness.
“I think investors are hopeful they get the best of both worlds,” said Alan McKnight, chief investment officer at Regions Bank.
There are some signs of caution among investors. The gains in recent weeks have been led by real estate and utilities, with the former seen as a primary beneficiary of lower rates and the latter a more defensive bet as the economy slows. The technology stocks that led the market rally for so many years have slipped over the past month.
Andrzej Skiba, head of U.S. fixed income at RBC Global Asset Management, said he did not see the case for a larger rate cut with the economy still in solid shape. But, he added, not all investors are in agreement at the moment.
“There is another cohort that sees much more ominous scenarios ahead that requires a bigger cut now,” he said.
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