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The Fed and China Gave Stock Investors Optimism, but There's One Problem

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Stock bulls had a lot to cheer about Wednesday, but there was one caveat in the mix market that investors likely won't miss. 

China said it would be interested in a highly conditional and partial trade agreement with the U.S. A risk-on move in the market ensued. All three major U.S. indices rose, with the S&P 500 up around 1% on the day. The 10-year treasury yield rose to 1.57%, with the 3 month treasury yield falling to 1.69%, as those two yields moved closer to reverting. 

But there was one glaring negative in what the Federal Reserve minutes of September showed, and it's certainly not a positive for stocks. 

First, here are all the particulars of the Fed and trade developments:

The Fed

Fed minutes from September indcate policy makers are open to cut rate rates to between 1.75% and 2%, as the U.S. economy continues to show weakness.

Recently, manufacturing activity contracted and net job additions missed expectations.

With lower rates, investors are incrementally -- or theoretically -- more bullish on inflation, prompting the move out of longer dated treasuries and into the risker stock market. 

China and Trade

In addition to the posibility of a coveted rate cut, China's apparent consideration of a partial trade deal was encouraging to investors. The positive impact of a return to free trade, many on Wall Street say, would outweigh the negative impact of fewer interest rate cuts that may come with that outcome, and stocks would do well.

But this trade deal is contingent on something: the White House would have to agree to cancel all tariffs scheduled to be implemented in mid October and December. 

Optimism was abundant in Wednesday's market. 

The Big Caveat

The Fed minutes showed that 7 of the 17 Fed members want another interest rate cut in 2019. Five members advocate for no action for the time being, and the other five members actually advocate for an interest rate increase, as the argument that the U.S. economy is strong is still alive. 

Still, the risk of a recession coming in 2020 or 2021 has been rising. Recently, the National Association for Business and Economics released a report saying the chance of a recession beginning at the end of 2020 is currently 60%. And with markets pricing in lower rates from these levels rather than higher ones, a more hawkish Fed could remove the bottom from the market. 

CME Group data shows the Fed Funds Futures market is pricing in an 82% chance of another rate cut in 2019. Much of the S&P 500's 2019 16.8% gain has been built on the expectation of rate cuts, several of which have already been implemented. Many have said that while trade is the most important factor in the market, lower interest rates have provided a "support" level for the economy and for stocks. 

Investors don't want to lose that support level. 

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