“Few precedents exist during the past 30 years where futures discounted an interest rate cut 30 days prior to a scheduled FOMC meeting but the Fed did not cut.” There were episodes in 1990 and 1992, but unlike today, both occurred in the middle of easing cycles.
Morgan Stanley’s Sheena Shah and Andrew Watrous:
The Fed rate-cut cycles since 1995 can be divided into two types: pre-euro and post-euro.
The pre-euro cuts -- in 1995, 1998 and 2001 -- resulted in the dollar rallying over the six months following the cut. The greenback’s performance before the rate cut had little significance for how it performed after the rate cut.
Following the post-euro cuts -- in 2002 and 2007 -- the dollar weakened significantly, around 10%. The currency’s realized and implied volatility picked up.
The bank’s cross-asset team expects the Fed to stay on hold until financial conditions tighten, by which time action will be too late to avoid cyclical impacts. They are underweight equities and credit and overweight high-quality bonds.
Wells Fargo & Co.’s Pravit Chintawongvanich:
“Although stocks have rallied with lower rates, they may start to sell off (or at least have limited upside) if rates keep declining.”
At some point the upside from “bad is good” is limited. An “insurance cut” scenario is already priced in, and would likely be positive for stocks; the Fed cutting more than one or two times by the end of the year would probably mean that the economy has significantly slowed and/or the trade war has escalated.
Chintawongvanich sees volatility elevated and potentially limited upside for stocks before the G-20 meeting. He says consider selling June VIX puts as VIX settlement is right before the Federal Open Market Committee decision. That VIX settlement will be based on 30-day option prices that “contain” the upcoming FOMC and G-20 meetings, and may keep a bid. Investors could sell the June puts to fund July puts, he adds.
--With assistance from Christopher Anstey.
This article was provided by Bloomberg News.