Rate Cut Decision: How 25 or 50 BPS Could Shake the Stock Market

The market had been heavily focused on a single event—NVIDIA's latest quarterly earnings report (NASDAQ: NVDA), which has now passed. Now that those are out, and the stock has had enough time to digest the results and send the stock to a new perceived valuation, the S&P 500 is awaiting the biggest event of the year.

On September 18th, 2024, the Federal Reserve (the Fed) will roll out its new interest rate policy for the stock market to either get excited about or reject, bringing on added volatility for investors to digest. For the first time in a while, this new Fed meeting offers what could be a one-directional bet, where both potential decisions might lead to a few days of bearish price action.

Before investors determine why that is the case after the Fed meeting, they should understand recent price action in different asset classes that send a warning message before major money shifts in financial markets. Some of this behavior is classified as a ‘flight to safety,’ when money shifts to places like the SPDR Gold Shares Trust (NYSEARCA: GLD) and the iShares 20+ Year Treasury Bond ETF (NASDAQ: TLT) to cushion volatility in stocks.

Markets Move on Expectations: Here’s What to Watch on Next Fed Meeting

The stock market is forward-looking, so investors must always be aware of expectations for the next few quarters regarding the economy and promotions that affect it, such as interest rates. Investors can utilize many tools beyond price action, but that's a good place to start.

The iShares 20+ Year Treasury Bond ETF has rallied by 15% in the past quarter, which means that treasury bond yields have come down as a result (the price-to-yield relationship is inverse in bonds). The 10-year treasury yield for the United States declined from over 4.6% to under 3.7% during that same period.

Bonds typically move ahead of the Fed's interest rate decision on the exact expectations that are driving the market today. That expectation, according to the CME’s FedWatch tool, is set for a 50% chance of a 25 basis point (bps) cut for this September meeting and a 50% chance of a 50bps cut as well.

Here's where it gets interesting. The market's rally in the past couple of quarters, along with the price action in commodities and consumer staples stocks like Costco Wholesale Co. (NASDAQ: COST), as bullish as it is, suggests that the market is leaning toward the 50bps cut rather than 25bps.

There is just one problem with a 50bps cut, though. It would basically mean that the Fed is admitting the United States economy is in such a deep slowdown that aggressive measures need to be taken to help it recover. Investors don't need to do much guessing to understand that this could probably trigger a stock market sell-off.

On the other hand, since a 50bps cut could be priced into the stock market today, a 25bps cut could be a major disappointment to the S&P 500 and trigger the need for every type of investor (from retail to institutional) to readjust their views as to where the stock market's true value lies.

Gold and Treasury Bonds Rise as Investors Hedge Against Volatility

This is perhaps why mega investors like Stanley Druckenmiller decided to jump out of NVIDIA and into the iShares 20+ Year Treasury Bond ETF (TLT) during the past quarter—and why gold, especially through SPDR Gold Shares (GLD), keeps making new all-time highs. The iShares 20+ Year Treasury Bond ETF, which tracks U.S. Treasury bonds with maturities of 20 years or more, has become a popular choice for those seeking a safe harbor in times of uncertainty. As bond prices rise and yields fall, TLT has rallied, signaling investor expectations for lower interest rates and an economic slowdown.

At the same time, gold, historically seen as a hedge against both inflation and market volatility, has been reaching new highs. The SPDR Gold Shares ETF has seen strong inflows as investors seek to diversify away from stocks and bonds. With both gold and long-term treasuries rising, it's clear that investors are positioning themselves defensively ahead of potential volatility in the stock market.

GLD and TLT offer a dual hedge—one through hard assets like gold and the other through U.S. government debt—both of which are traditionally safe assets in times of economic stress. As investors brace for the Fed's next move, these defensive plays may continue to gain traction.

These expectations are currently driving stock market price action and are key for investors to monitor during what could be a volatile month ahead.

New Price Action Warnings and Expectations Emerge for the Market

Warren Buffett has also decided to leave some of the financial stocks that could be affected by either of the Fed's decisions. By leaving Bank of America Co. (NYSE: BAC) and Capital One Financial Co. (NYSE: COF), Buffett might be jumping ship before the market experiences a run of higher volatility.

Speaking of Buffett leaving the financial sector, one of the first stocks to reflect the potential future price action of the S&P 500 is, in fact, the financial space, particularly banking stocks. Recently, both Goldman Sachs Group Inc. (NYSE: GS) and J.P. Morgan Chase & Co. (NYSE: JPM) sold off by close to double-digits in a single week.

The bearish sentiment that took over these names can be attributed to warning signs from Goldman’s CEO David Solomon, who stated that he expects to see a worse-than-expected 10% decline in the bank’s trading business. As high interest rates have compressed business activity, deal-making in these banks could also deliver another hit.

These are typically the early warning signs of potential volatility, and now investors understand how the next Fed meeting might be a one-way bet with downside potential. Both scenarios could deliver a down move for the S&P 500 in the coming weeks.

The article "Rate Cut Decision: How 25 or 50 BPS Could Shake the Stock Market" first appeared on MarketBeat.