US stocks saw a mixed performance on Monday, with investors treading carefully ahead of the Federal Reserve’s key policy meeting on Wednesday.
The S&P 500 finished 0.1% higher, while the Dow Jones gained 228 points, hitting a new record high, and the Nasdaq slipped 0.5%.
Chipmakers, which helped fuel the market's recent recovery, also slid as investors reduced their positions, leading to 2% declines for Nvidia and Broadcom.
On the flip side, the energy and financial sectors outperformed, led by a 1% rise in Chevron and 1.7% increase in JP Morgan shares.
The Fed will cut rates on Wednesday.
By how much, probably has more to do with preserving global financial stability than preserving labour market stability (at least for the moment).
On the latter, this first rate cut will come in reaction to "cracks" in the labour market that have developed as a result of the Fed holding real rates (the Fed Funds Rate minus the inflation rate) too high, for too long.
So, the Fed wants to stabilise the employment situation and it has a lot of room to cut/ to stimulate. In fact, as you can see in the chart below, they could cut by more than 200 basis points to get to the level they deem to be "neutral" (not stimulative nor restrictive).
Of course, a huge slash of rates won't happen.
As the Fed (and the world) discovered early last month, the prospect of rates moving lower in the U.S., while rates are simultaneously moving higher in Japan (as Japan is exiting its emergency level policies that have supported global markets the past two years), presents a shock risk to global liquidity and global financial stability.
How did the market react last month? A massive spike in the VIX and a three-day loss in the Nikkei (Japanese stocks) comparable to only three other periods over the past thirty years: the darkest days of the Global Financial Crisis, the tsunami and the Covid lockdown.
So, both the Fed and Bank of Japan will again determine policy this week. We should expect the Bank of Japan to hold the line (do nothing to incite a market reaction).
But the Fed will cut.
And whether or not the Fed will trigger a negative reaction across global markets will likely have to do with:
how big of cut,
how they manage expectations on the speed and depth of future cuts.
With that, the market is now leaning towards 50 basis points. We've heard a former Fed governor calling for 50. Elizabeth Warren, the Senator from Massachusetts, wrote a letter to the Fed calling for a 75 basis point cut.
Given the shock risk, my bet is on 25, and a Fed that positions the cuts as just "reducing restrictions" and maintaining focus on the inflation fight.
In line with that view, the Bank for International Settlements (the "BIS," a consortium of the world's top central banks) published a well-timed report, urging central bankers not to "squander" the interest rate buffers they have built over the past couple of years by cutting too rapidly.
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