Tommorrow is the all-important Federal Reserve monetary policy announcement, so I wanted to take a look at what the market is expecting and how it might react to the announcement.
As of this afternoon the Fed Funds futures were pricing in a 54% chance of a 50 basis point cut and a 46% chance of a 25 basis point cut. Interestingly, economists are far more decisive that a 25 basis point cut will be coming. 78% of the economists Bloomberg polled believe there will be a 25 basis point cut while only 18% believe there will be a 50 basis point cut. There is clearly a disconnect between the market and the economists on what the Fed is likely to do with the fed funds target rate tommorrow.
How will stocks react to the news of a 25 basis point cut or a 50 basis point cut? The completely honest answer is that no one truly has any idea, but I'll venture a guess. I believe that the key will be in the statement that the Fed makes about the future of the economy. If the Fed cuts by 25 basis points and talks a lot about inflationary pressures remaining and doesn't hint at future moves, the market is likely to fall precipitously. If the 25 basis point cut is accompanied with language of further cuts probably being necessary, the market may receive a bid. I believe that the wording will be the key if there is a 50 basis point cut as well. If the Fed cuts by 50 basis points and speaks of impending economic doom, the market will selloff. If the Fed cuts by 50 basis points and says that the subprime fallout should be contained the market may catch a bid.
The key sectors to watch tommorrow after the FOMC announcement will be the financials and the consumer cyclicals. Financials like Bank of America (NYSE:BAC), Wells Fargo (NYSE:WFC), and Morgan Stanley (NYSE:MS) will likely trade directly on what the Fed announces tommorrow in the short-term. Likewise, consumer cyclical companies such as Coach (NYSE:COH), General Motors (NYSE:GM), and American Eagle Outfitters (NYSE:AEO) will be volatile tommorrow. The consumer cyclicals will be especially vulnerable should the Fed talk poorly about consumer spending and especially likely to benefit if the Fed speaks of the consumer holding up.
I worry that the fact that 54% believe there will be a 50 basis point cut will hurt us tommorrow. Expectations have gotten so high that anything less could hurt the market greatly. Only time will tell precisely how the market will react to the FOMC announcement.
You may also be interested in reading my detailed FOMC announcement preview from earlier tonight, which highlights the difficult decisions that the Fed has in front of them tommorrow.
Comment Preview