Probability of Two Fed Rate Cuts Falls as Optimism on US China Trade Deal Rises

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Stocks were falling Monday, and it seems the drift of the market was leading stocks slightly lower after a great week heading into mid-September. 

But one data point that emerged Monday is a clear negative for stocks. The probability the Federal Reserve will cut interest rates twice in 2019 dropped to 69% Monday from 78% last week, according to CME Group's FedWatch Tool. The S&P 500 was falling 0.25% on the day. This comes after a strong week for U.S. stocks, as President Trump and Chinese leader Xi Jinping had both showed clear and encouraging signs of moving back towards a constructive trade relationship, rather than one defined by tariffs and retribution. 

But the bond market was already signaling incrementally less optimism on rate cuts last week, as the potential removal of economic drag caused by the trade war makes rate cuts a less obvious choice for the Fed. The 10 year treasury yield rose to 1.89% last week, after having been stuck at 1.55% for several days. That yield is down slightly Monday, to 1.85%, as the 3-month yield rose to 1.98%, putting the yield curve deeper into inversion. 

Friday, news broke that China said it will exclude U.S. soybeans and pork from its round of tariffs against the U.S. President Trump also said he may consider a partial trade agreement with China as part of the goodwill the two sides have shared regarding trade in the past two weeks or so. Trump and Chinese leader Xi Jinping will meet in October and U.S. stock investors have grown considerably more optimistic there will be a comprehensive trade deal. 

Friday morning, the S&P 500 rose 0.3%. The index is now up 19.5% year-to-date, a slightly lower gain than where the index was Friday. Friday's market featured a classic "risk-on" movement, but the risks relating to interest rates seems to have been reconciled in Monday's "risk-off" action. 

Expectations of rate cuts have served as a boon to equities of late. Many on Wall Street have said recently that if all threatened tariffs go into effect, the economic drag from such events would outweigh the positive impact of lower interest rates, which means rate cuts would be merely "supportive," rather than necessarily stimulative to stock prices. Conceivably, stocks could tumble even more should the Fed signal it won't cut rates twice in 2019. 

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