Fed Cuts Rates Again, This Time by a Quarter Point

US: The Federal Reserve approved a quarter-point interest-rate cut Thursday, the latest step to prevent large rate increases of the prior 2½ years from weakening the labour market as inflation eases.

The decision, coming the same week as the election of Donald Trump to a second presidential term, followed an initial cut of a half-point in September and will bring the benchmark federal-funds rate to a range between 4.5% and 4.75%. All 12 Fed voters backed the cut.

Officials have said those moves are warranted because they are more confident that inflation will return to the central bank’s target and because they believe rates are still high enough, even with the latest cuts, to dampen economic activity.

The move was expected. Stocks and Treasury yields were steady after the announcement.

“We are committed to maintaining our economy’s strength,” Fed Chair Jerome Powell said at a news conference. He said officials are confident that with an “appropriate recalibration of our policy stance,” inflation can continue heading lower with a solid economy.

Trump’s election victory this week has the potential to reshape the economic outlook, with presumed GOP majorities on both sides of Capitol Hill enabling a broad shift on taxes, spending, immigration and trade. Economists are divided over whether the mix of policies will boost or weaken growth and drive up prices.

The shift in the outlook, in turn, has fuelled questions on Wall Street over whether the Fed will alter its earlier expectation that rates could be steadily dialled lower over the coming year or two.

Powell said it was too soon to say how the next administration’s policies would reshape the economic outlook.

“We don’t guess, we don’t speculate, we don’t assume” what policies will get put into place, Powell said. “In the near term, the election will have no effects on our policy decisions.”

Powell also said he had no intention of leaving the Fed before his four-year term as chair expires in May 2026. “Not permitted under the law,” Powell said when asked if he believed the president could remove him or other Fed personnel from their positions before their term expires.

Since the Fed cut rates in September, longer-dated bond yields have climbed notably, meaning the cost to borrow for a mortgage or car loan has gone up. Yields have increased in large part because better economic data has led investors to reduce their worries about a recession, which could have triggered larger rate cuts.

But some analysts think the bond-market selloff may also reflect concerns by some investors about higher deficits or inflation in a second Trump administration.

Either way, the market has generated an unusual result: Borrowing costs rose after the Fed cut rates. The average 30-year mortgage rate has jumped since mid-September, to 6.8% this week from 6.1%, according to Freddie Mac.

Over a similar time frame, investors in interest-rate futures markets have steadily reduced their expectations over how much the Fed will cut rates over the next year or so. They now see the Fed cutting rates to around 3.6% by 2026, up from an estimated trough of 2.8% in September, according to Citi.

Officials are trying to bring rates back to a more “normal” or “neutral” setting that neither spurs nor slows growth. But they don’t know what constitutes a normal rate. Policies that boost economic activity or prices could also lead officials to conclude that they should maintain a moderately restrictive rate stance. That means they would hold rates somewhat higher than a normal or neutral level.

Before the 2008-09 financial crisis, many thought a neutral rate might be around 4%, but after the crisis and an extremely sluggish recovery, economists and Fed officials concluded the neutral rate might be closer to 2%.

Interest-rate projections that officials submitted in September show most of them expected that if the economy expanded solidly with inflation continuing to cool , they could cut rates to around 3.5% next year.

Inflation based on the Fed’s preferred index was 2.1% in September, from a year earlier. A separate measure of so-called core inflation that strips out volatile food and energy prices was 2.7%. The Fed targets 2% inflation over time.

Because officials don’t have much conviction over where the neutral rate sits, they are likely to be guided by how the economy performs in the months ahead. If inflation keeps slowing and the demand for workers looks soft, officials could conclude it makes sense to continue cutting rates along the path they envisioned in September.

“We’re going to move carefully as this goes on so we can increase the chances that we get it right,” Powell said. “We’re trying to steer between the risk of moving too quicky…or moving too slowly. We’re trying to be on a middle path.”

If inflation progress stalls or ebullient financial markets raise concerns that inflation might get stuck above their target, officials might face more reservations around continuing to cut rates at a steady, meeting-after-meeting clip.

The most immediate focus is whether the Fed will cut again at its upcoming meeting in December. In September, 19 participants were about evenly divided over whether to cut rates one or two more times this year. Nine of them penciled in no more than one cut in either November or December, while 10 penciled in two cuts.

“There’s a lot to learn between now and the December meeting,” said Diane Swonk, chief U.S. economist at KPMG. “They can’t leave the door wide open, but they can’t close the door either.”

Powell said Thursday it was too soon to rule anything “out or in” at that meeting. Slowing down the pace of rate cuts is “something we’re just beginning to think about,” he said. “We’re on a path to a more neutral stance. That has not changed at all since September. We’re just going to have to see where the data lead us.”

Even before the election result, recent data suggested that cutting again would be a finely balanced decision because inflation looks like it might end the year slightly above officials’ projection, while the unemployment rate has edged lower recently, said Matthew Luzzetti, chief U.S. economist at Deutsche Bank.

The election result— which sent stock markets to new highs while raising the prospect of stronger growth, higher inflation and better labour-market outcomes—boosted the odds that the Fed forgoes a cut next month, he said.

“Those could present a strong case from a risk-management perspective to potentially skip that meeting,” said Luzzetti.

Wall Street’s hottest trade has gone ice cold.

For years, it paid off to buy stocks that were rising in price—and bet against struggling shares. The momentum trade was especially profitable this year, as investors piled into hot stocks including Micron Technology, Nvidia, Advanced Micro Devices and other artificial-intelligence darlings while wagering against those likely to be hurt by the embrace of AI.

The S&P 500 Momentum Index soared 44% in the second quarter, its best quarterly performance on record, and it surged 133% over the past five years, nearly double the broad market’s performance.

Mega funds and rookie investors alike piled into the trade, some using leverage and options contracts in an effort to amplify their returns, propelling the underlying shares higher.

“It is a self-fulfilling prophecy,” said Matthew Tym, managing director at Cantor Fitzgerald, of the trade.

Suddenly, the trade is a loser. The momentum index has tumbled more than 9% since July 1, lagging behind the S&P 500’s 2.8% gain. The index—which tracks stocks in the S&P 500 based on a “momentum score”—is on track for the biggest quarterly underperformance in 25 years. July was the second-worst month for the momentum trade in around 40 years, according to Bank of America estimates; the only month worse was April 2009, in the teeth of the global financial crisis.

Hedge funds that bought momentum shares while shorting low-momentum stocks suffered even more. At the same time, a basket of the most popular stocks held by hedge funds tracked by Goldman Sachs recorded its biggest one-month underperformance in July relative to the S&P 500 in more than 20 years, according to the bank’s analysts.

Momentum trading is based on a rather simple observation: Investments that go up tend to keep outperforming; those that underperform often remain laggards. This kind of trading might seem too simple a stock-picking strategy to work. Yet it often has.

“For decades, it didn’t take a lot of sophistication to run a momentum strategy and make a decent living at it,” says Agustin Lebron, senior researcher at EquiLibre, a trading firm.

Part of the reason: It takes a while for corporate and other information to spread to various investors, so they slowly build positions, producing buying momentum.

“A huge pension fund can’t flip around its positions in a day,” says Lebron. “Behavioral biases also account for some of the effect, as well—people tend to sell their winners too early and hold losers too long.”

Fans of the strategy point to the human tendency to extrapolate from past results—and chase investment returns—noting that momentum patterns have been evident in markets for decades, even centuries. They also say that some of the worst months for momentum strategies are during longer periods of outperformance.

Some have been doing the trade by buying the strongest investments in a sector while shorting the weakest; others lean in to rising markets or asset classes. Still others use a quantitative approach or turn to banks or others who sell ways to make distinct wagers on momentum as a “tradable factor” or a “thematic basket.”

The fans remain believers. “Any strategy has disappointing periods,” says Antti Ilmanen, global co-head of the portfolio solutions group at AQR Capital Management.

The surge in Moderna and other biotech stocks helped crush the momentum trade. These shares were among the most heavily shorted in recent years, but positive news on a cancer vaccine from Moderna and Merck sent those stocks flying, crushing some quant and other hedge funds. Moderna is up around 150% so far this month.

These traders had an especially rough day on Aug. 19, which Goldman Sachs told its clients was the worst day for “systematic long-short managers” in more than two years. About half of the losses were because of momentum trades, the bank said.

Some traders have begun to short, or bet against, the very stocks that propelled the momentum trade earlier this year. Net short positions in futures tied to the Nasdaq-100 index among speculators recently climbed to some of the highest levels of the past two decades, according to data from the Commodity Futures Trading Commission.

The about-face is a sign of how markets have become more treacherous for investors, even as indexes keep climbing. Part of the issue: the recent meltdown of Situational Awareness, a hedge fund that had piled into some of the most popular momentum shares, including chip stocks. After a period of market tumult, Nvidia shares rocketed almost 9% after its earnings, showing how quickly sentiment can shift.

Some investors say the run-up in share prices driving tech stocks higher reminds them at times of the dot-com frenzy decades ago.

Mike Ogborne, the founder of San Francisco-based Ogborne Capital Management, said he has grown more cautious on technology stocks and is keeping more of his portfolio in cash than he typically does.

And he is nervous about the surge in spending by technology giants and quarterly capital expenditures that keep rising.

“It is a little bit like Cinderella and the clock striking midnight. You don’t know when midnight is going to come around,” Ogborne said. “They don’t send a memo around telling you when the capex cycle is over.”

Fed Cuts Rates Again, This Time by a Quarter Point

Powell says he has no intention of leaving Fed before his term expires

Wall Street’s hottest momentum trade has reversed sharply, as former winners tumble and heavily shorted stocks surge.