Shifting Probabilities For Future Rate Cuts Drive The S&P 500

If you block out the noise coming out of Washington D.C., as most investors do, the fourth and final full week of September 2019 saw a lot of good news for the U.S. economy. Even the ever uber-pessimistic Tyler Durden grudgingly acknowledged as much before setting the stage for future doom:

The last few weeks have seen a dramatic surge in US macro data surprises (to the upside), dramatically diverging from the rest of the world (and almost single-handedly improving the global data)…

ZeroHedge chalks much of that effect to the U.S. government’s “Use It Or Lose It” end-of-fiscal-year spending, which they argue is having a short term stimulative effect on the U.S. economy. Which will soon come to an end (this is ZeroHedge, after all)!

But the Tylers are good observers of the market and we can confirm the cumulative effect of the upside economic data surprises with the CME Group’s FedWatch Tool, which not only no longer indicates any rate cuts after 2019, but also indicates the falling probability of a rate cut in the fourth quarter of 2019 (2019-Q4):

That’s good news, but in the chaotic math of how stock prices work, that means investors are shifting their forward-looking attention inward from the distant future horizon of 2020-Q1 toward 2019-Q4, which means that stock prices would fall given the expectations associated with that quarter.

That may be the start of the sixth Lévy flight event of 2019, although at this point, we may see investors opt to split their focus between 2019-Q4 and 2020-Q1, where we might not see another full quantum-like shift from the trajectory for 2020-Q1 to the alternate trajectory for 2019-Q4 like we did earlier this quarter.

If we do, it will be associated with a much larger drop in stock prices than occurred in early August 2019, because the expectations for the change in the year-over-year rate of growth of future dividends for the S&P 500 has changed, with a larger gap opening up between the alternate trajectories associated with investors focusing on either 2019-Q4 or 2020-Q1.

If the flow of upside surprises slows and negative surprises start to take hold however, we could see stock prices rise with the increased probability of a rate cut in 2020-Q1. Or the picture for the economy may continue to improve, which would seemingly paradoxically send stock prices lower as the potential for one last rate cut before the end of 2019 becomes a point of focus.

Or investors could have reason to shift their attention to another point of time altogether, with the trajectory of the S&P 500 shifting accordingly. No matter what, the current market environment is ripe for stock prices to experience a lot of potential volatility. If you know which way it’s going to go, more power to you!

Speaking of the current market environment, here’s a sampling of market-moving news headlines from the fourth week of September 2019:

Monday, 23 September 2019

• Oil rises about 1% on concerns about return of Saudi output

• Saudi Arabia to restore full oil output by next week: source

Chinese farm official says ‘good outcome’ from trade talks

• China buys about 10 cargoes of U.S. soybeans after trade talks
• Chinese U.S. homebuying to hit eight-year low, says leading property site
• Fed’s Bullard: U.S.-China relations probably had to come to a head

Bigger trouble developing in the Eurozone:

• Euro zone economic rebound not in sight: ECB’s Draghi
• German private sector shrinks in September for first time in over six years: PMI

Bigger stimulus developing in China:

• China’s Premier Li: will ensure economic operations are within reasonable range: Xinhua

The Fed’s $400 Billion Plan to Bailout the Repo Market

• NY Fed’s Williams says NY Fed actions had desired effect of reducing market strains
• Fed’s Bullard says prefers standing repo facility to ensure smooth markets in the future

Wall Street ends flat as mixed economic data signals caution

Tuesday, 24 September 2019

• Oil drops to lowest since Aramco attacks after Trump scolds China
• Fed policymakers say lower rates are helping

• Fed’s Daly says rate cuts are helping to offset headwinds

Trump’s China trade rhetoric turns harsh at U.N., says won’t take ‘bad deal’

S&P 500 hits two-week low on Trump impeachment call, weak consumer data

Wednesday, 25 September 2019

• Oil falls about 1% on surprise U.S. crude build, Saudi crude output
• India’s stuttering economy hits global oil demand
• Lower mortgage rates stimulate lethargic U.S. housing market
• Fed minions pat selves on back:

• Evans says two rate cuts have Fed ‘well-positioned’ at this point
• Evans: Larger balance sheet may avoid future repo market problems
• Trump impeachment inquiry not a problem for the Fed: Bullard

Wall Street bounces back as investors shrug of impeachment risk

Thursday, 26 September 2019

• Oil steady as Middle East conflict fears support, Trump probe weighs
• China’s top diplomat says Beijing willing to buy more U.S. products
• Fed minions issue statements on life, the universe, everything:

• Fed’s Kashkari: U.S. economy needs lower interest rates
• Fed’s Clarida says inflation expectations in line with mandate
• Dallas Fed’s Kaplan: U.S. needs more, not less, immigration for economic growth
• Dallas Fed’s Kaplan says global economy ‘fragile’ but U.S. will ‘skate through’
• U.S. Fed should target repo rate to reduce market volatility: ex-Fed officials

Wall St dips as whistleblower report adds to investor caution

Friday, 27 September 2019

• Oil prices post weekly loss as supply fears wane
• Bigger trouble developing in China:

• China’s Aug industrial profits fall as headwinds hit firms

Fed’s Harker opposed last rate cut, says officials should ‘hold firm’ on rates

Wall Street falls on China trade worries

• Trump considers delisting Chinese firms from U.S. markets: sources
• U.S.-listed China shares, indexers fall after delisting reports

Barry Ritholtz outlines no fewer than eight positives and negatives each that he found in the past week’s economics and market-related news.