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Here’s how dependent stocks are on more Fed rate cuts

As August comes to a close, one can’t help but wonder just how dependent risk assets have become on everything from tweets to rebalancing. The biggest form of life-support, however, still comes from the Fed: equities are in a world of total dependency. At a minimum, the S&P will require more than 2 rate cuts by the end of the year just to maintain current valuations.


Here’s a rough idea – some numbers behind the “Fed put”.

Over the past month, here’s the performance of the S&P over 3 different time slices (avg annualized returns, 10-min windows).

  1. When the September FOMC is priced for 25bps or less (1 cut or less): the S&P avgs a -0.62% annlzd return.
  2. When the September FOMC is priced for more than 31bps cuts (at least 1 cut & chance of more): the S&P avgs a +0.92% annlzd return.
  3. When there is something in between: the S&P is essentially unchd.

For reference, here’s what the options market is pricing in terms of a probability distribution for the September FOMC. Equities stumbled today as we approached pricing in “only” a -25bp cut in September: that should be fair warning to those who recall the price action into & out of the July 31 FOMC this year.

Similarly, for pricing between now & yr-end it’s clear that the S&P would very much like at least 3 cuts from the Federal Reserve.

  1. When less than 55bps is priced between now & yr-end: the S&P avgs a -1.17% annlzd return.
  2. When more than 65bps is priced between now & yr-end: the S&P avgs a +1.10% annlzd return.
  3. When there is something in between: the S&P is essentially unchd.

For more discussion on this dynamic, see here & here.

Here’s the distribution of returns under the “year-end” time-table for these 3 states of the front-end. Note positive skewness under only the scenario that includes “-65bps or more” worth of cuts priced by year-end.

That’s ~2.5 cuts for those following along at home.

At a minimum.

Such a dependency can only be characterized as terminal for equities which have relied upon a scotch-taped support mechanism of rescue-by-tweet, negative gamma, and forced pension buying during the month of August.

September should be “interesting.”

Prices from CME website, Bloomberg.

https://www.cmegroup.com/trading/interest-rates/stir/30-day-federal-fund_quotes_globex.html

https://www.newyorkfed.org/markets/data-hub

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