The anatomy of a rate cut

Marius Paun | London, UK | Senior dealer | Thursday, 01st August 2019

Yesterday, the US Federal Reserve cut its benchmark interest rate by a quarter of percentage point to a range of 2%-2.25% which was the first cut since 2008. Usually, stock markets enjoy when the Fed slashes rates as easing means cheaper funds which at least partially will go back into stocks, propping up prices.

However, the outcome was a drop in US share prices coupled with a higher US dollar. One could easily think neither result was intended. That seems to be opposite to a logical intention because its rather hard to believe the Fed wanted a lower stock market and/or a stronger dollar at the present time. A stronger dollar makes it harder to pay down debt as well as hurting exporters in the current trade disputes. And a slumping stock market going into election is bad for politics. President Donald Trump has been tweeting continuously, bragging about the all-time highs in shares and at the same time ‘advising’ the Fed to take measures to weaken the US dollar.

So let’s see what happened in detail.

By and large the markets had been widely expecting a very dovish Fed which means a 25basis point cut accompanied by hints the second and eventually third cut will follow by the end of the year. But faced with a rather stronger than anticipated economic data lately, the Fed struggled to justify the decision going into the meeting. It blamed the US trade policy, slowing global growth and a lingering below target inflation. Many called it ‘an insurance cut’ reminiscent of ‘Greenspan put’ (a cut in interest rates done by the former Fed Chairman at the first sign the US economy went into troubles).

Nonetheless, during the press conference that follow the decision Fed Chair Jerome Powell described the cut as a ‘mid-cycle adjustment’ adding that ‘it was not the beginning of a long series of rate cuts’. The markets were shocked and interpreted the comments being rather on the hawkish side. After all they were widely expecting a dovish statement, betting on interest rates being pretty much a full percentage point lower in the next 12 months.

In reaction, the US dollar strengthened hitting a more than two year high and the Dow Jones fell 478 points initially. It closed the day 330 points down in its worst session since May.

Now we know that the midcycle adjustments down in 1995 and in 1998 were 75 basis points each (three cuts each). On the other hand, usually when the Fed starts cutting is not a one off move. Is Powell trying to say yes I’m going to make it easier for you markets but not that easy? So poor communication or not we might expect the next Fed decisions to be more data dependent.

The main trend Dow Jones according to the chart is down. The trend turned south mid July as we can see a string of lower highs and lower lows in a move that was exacerbated with yesterday’s big drop to 26,718. The price action needs to see a rise above high of 27,402.5 seen on July 15 for the long term trend to turn bullish again.

Bearish outlook

The next immediate support is around 26,720 which held its ground during the last test. A sustain move below that level will signal the growing presence of sellers and opened the door for a test of 26,640 where bulls and bears were at loggerheads in late June. If that level fails then look for selling pressure to test 26440.

Bullish outlook

A slight rebound is currently underway but it’s hardly bargain hunting feeling more like a dead cat bounce at the moment. We need to see at least a rise above 27,000, next resistance ( and 9 day moving average ) to indicate the presence of returning buyers. If the rally back then creates enough upside momentum investors could see the rebound extend to 27,078 and possible 27,157.

To be noted that yesterday violent nosedive took the price below both 9 and 21 days moving averages and in another bearish sign 9 day moving averages crossed below the 21 days moving averages.