The markets are looking forward to a reduction in less than two weeks in the federal funds target rate. According to the CME FedWatch tool, there is a 59% chance that the Federal Open Market Committee will reduce the federal funds target rate by 25 basis points. This means that the overnight rate target range for borrowing bank reserves in the interbank market will fall to 5.00%-5.25% from 5.25%-5.50%.
Typically, what happens almost immediately is that large banks will decrease the interest rates they offer to customers. When the FOMC reduces the target range, it is done in hopes of stimulating economic activity. It is hoped that lower rates encourage more borrowing and that borrowed funds are injected into markets.
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If the injection is successful, then traders should see some benefit from appreciation in bond and currency prices as investors bring higher valued collateral to prime brokers and prime brokers issue loans with lowered interest rates leveraged by higher value collateral.
But I am not too sure about this theory. Some of the asset managers, economists, analysts, and other talking heads appearing on Bloomberg, CNBC, and Fox Business are observing a weakening economy. The 818,000-job revision reported by the U.S. government occurring over the 12-month period prior to March 2024 substantiates some of this concern. If fewer people than we thought are working, these individuals are not able to consume or made available as taxpayers.
My contrarian view is, wouldn’t a falloff in consumption and tax availability make an economy a risky bet? Even if borrowing becomes cheaper, does less expensive capital necessarily translate into finding high yielding opportunities? If there is additional risk in the system, why shouldn’t the federal funds target rate increase to reflect this risk? Also, why make more money available to bid up already high prices?
I can see myself betting on an event where dollar purchasing value falls along with demand and price for the currency. If I played in the equities markets, I would short stocks. Which ones, I do not know. More importantly, I would want to remain mindful of risks in this economy no matter how rosy a picture the current administration wants to paint.
Alton Drew
5 September 2024
Disclaimer: The above post should not be viewed as investment advice. Please consult a registered investment adviser. Affiliate links are found in this post. I may be compensated by an affiliate should you purchase their product.
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