Protecting the Dollar?

• Stocks in the US closed a volatile session lower after the Fed delivered a 50bps rate cut, its first cut since 2020, and above the 25bps expected by a majority of surveyed economists.

• The S&P 500 and the Nasdaq 100 lost 0.3% each, and the Dow fell 102 points with the latter gaining over 375 point earlier in the session.

• Still, projections by FOMC members pointed to a median of 100bps in total rate cuts for the year, translating to 25bps in each of the central bank's meetings this year.

• Nvidia, Microsoft, Oracle, and AMD fell over 1%.

• On the other hand, Apple added 1.8% while Meta traded slightly above the flatline.

The Fed cut rates by half a point.

And they project another half point cut by year end.

And it has everything to do with the employment situation.

We've talked for months about the clear "cracks" in the labour market. The Fed told us back in March that unexpected weakness in the labour market was a condition for a policy response.

Yet they did nothing while watching the unemployment rate rise at a rate-of-change consistent with the past four recessions, and (in each case) consistent with a Fed easing cycle.

So they come in now, not with just a cut, but a large cut, and projecting another 50 bps by year end, and another 100 basis points by the end of next year.

What signal should the market take from this?

We don't have to guess. Jerome Powell told us what signal he wants the market to take from this. He said, they don't think they are behind the curve, and that this "strong move" should be taken "as a sign of our commitment not to get behind the curve."

Translation: If the job market deteriorates further, he says "we have the ability to react to that by cutting faster."

So, how did markets respond?

It should have been;

• Stocks up.

• Yields down.

• Commodities up.

• Dollar down.

What happened?  

• Stocks: Up first, then down. 

• Yields: Down first, then up. 

• Commodities: Up first, then down. 

• The dollar: Down first, then up.

This outcome for markets, by end of day, was the opposite of what you might expect for a Fed move that lightened the brake pressure on the economy, and with plenty of promises that they will do what it takes — that they are "committed to a good outcome" (i.e. stabilising the labour market and averting an economic downturn).

This odd market behaviour brings us back to my Aug 01 note, just following the Fed's last meeting.

Given the Fed's reluctance to move in that July meeting, despite the obvious drag that rates were having on the economy, and the clear weakness that had developed in the labour market, I asked: Are they not moving because they are worried about the dollar - preserving global capital flows to protect the dollar? 

As we now know, the sharp unwind of the carry trade accelerated the next day, leading to a sharp drop in the dollar. It was only stabilised by verbal (and likely actual) intervention from the Bank of Japan.

The Fed news was clearly dollar bearish. Yet, the dollar went up.

Are the Fed and the Bank of Japan coordinating to maintain stable markets?  Likely.