Optimism is surging the FOMC will lower rates next week and perhaps three more times in 2026. This outlook is/was the catalyst for last week’s markets advance
As noted many times, over the last five years the disconnect between market expectations and Fed policy was great. Moreover, there was/is also a large difference between what the Fed stated what they were planning to do and what they actually did.
A strong argument can be made that the Fed is losing effectiveness in part due to the fiscal irresponsibility of Congress. $2 trillion and growing budget deficits have made effective monetary policy almost impossible. Markets now expect the Federal Reserve to step into any crisis and fix things via lower rates, liquidity, balance sheet actions, QE, etc. But these tools no longer work well because of fiscal irresponsibility.
The Fed’s supposedly enormous power is why the markets hang on every Fed speech. When or if this narrative fails, the bond market could grow wildly chaotic and no matter what the Fed does, no matter what the Treasury does, it is too late to change.
The dissention within the FOMC is growing. For many years, decisions on monetary policy were unanimous. In many regards it was “Group Think”
Today dissents are growing. No longer are the votes 12-0. We are now on the path where 3-4 dissents may become normal. How will these dissents be interpreted by the markets? Will the markets glean more information from a 7-5 vote?
As noted in the introductory paragraph, last week the markets staged a strong advance following dovish comments from several Federal Reserve officials. About 10 days ago, there odds of a December interest rate reduction were about 25%. Today the odds are over 80%, odds or perhaps higher given the distinct probability a monetary dove could be appointed as the next Fed Chairman.
All must remember the Chairman has only one vote and is the spokesman for the rest of the Committee comprised of 19 total members, twelve of which vote on a rotating basis.
Even before the government shutdown, for a myriad of reasons the economic outlook [and direction of monetary policy] was murky at best.
To make decisions, assumptions are required. How do these assumptions unfold? Sometimes the assumptions unfold as believed but the market responds completely differently than expected or as it had in years past under similar circumstances. The question is why?
Some believe that passive indexing is the vehicle to avoid economic thought. Indexing may work for a period, but indexing does not rely upon economic or corporate outlooks but rather by momentum and size [all fueled by technology or algorithmic trading]. There is no financial or economic analysis, just blindly buying shares based on capitalization.
Many are “shocked” by the 38% plunge in Bitcoin in about 40 trading days as there is no apparent catalyst. A strong argument that can be made the drop is the unwinding of leverage bets, leverage that was perhaps not known.
Many are also distressed by the 25% thirty day drop in NVDA , a decline that occurred on great earnings and forward-looking statements. NVDA’s capitalization fell by almost $1 trillion, a plunge that is more than the value of 490 S & P 500 members. Why? The unwinding of leverage trades that almost everyone had ensued?
There are always more questions than answers. Ultimately reality or the ramifications of past actions do return.
What will happen this week?
Last night the foreign markets were down. London was down 0.17%, Paris down 0.94% and Frankfurt down 1.60%. China was up 0.65%, Japan down 1.89% and Hang Seng up 0.67%.
Dow and NASDAQ futures are down 0.5% and 1.0%, respectively. Bitcoin is down about 5%. The yield curve is the steepest since early 2022 as Japanese debt is selling off and it believed that Kevin Hassett may be the new Fed chair, a perceived monetary dove. The 10-year is off 5/32 to yield 4.04%.
