trader reacts
The Fed officially announced a 25-basis point cut. The U.S. stock market and the S&P 500 reacted with a sharp correction. | Source: Spencer Platt / Getty Images / AFP

On July 31, the U.S. Federal Reserve and its chairman Jerome Powell officially announced a 25-basis point cut. The U.S. stock market and the S&P 500 reacted with a sharp correction, indicating that the rate cut has been priced into the equities markets.

The S&P 500 has dropped by more than one percent on the day following the Fed's rate cut
The S&P 500 has dropped by more than one percent following the Fed’s rate cut. | Source: Yahoo Finance

Kathryn Rooney Vera, chief markets strategist at Bulltick Capital Markets, said in an interview with CNBC prior to the rate cut that the market is likely to react with a pullback. If it does, Vera stated that it may be a sensible move to re-enter the market once the retracement occurs.

Why the U.S. stock market and S&P 500 reacted with a drop

The Dow Jones slipped by 1.23 percent on the day and the S&P 500 dropped by more than 1 percent subsequent to the formal announcement of the Fed.

According to Vera, investors may have expected multiple cuts citing geopolitical risks due to the struggling U.S.-China trade talks and the slowdown of the growth of the eurozone throughout the past month, adding to the momentum of the U.S. equities markets.

Prior to the rate cut, from July 18 to July 31, the S&P 500 increased from 2,976 points to 3,025, reflecting the optimism of investors toward the short-term trend of the market.

However, the Federal Reserve settled with one 25-basis point cut possibly due to rising productivity levels in the market and record low unemployment rates, not meeting the expectations of most investors.

In late July, before the announcement of the rate cut, Vera said:

“The market is pricing in way more than I think they are going to actually deliver between three to five cuts in the environment full employment, above potential transeconomic growth and record high equities markets seems way beyond what the Fed is likely to deliver, in which case one has to ask oneself what will the reaction be in the markets. I think that’s going to be to the downside and that’s why I am recommending put options to guys who are ready to forfeit 3.5 percent of their return year to date.”

Vera emphasized that if the market retraces and experiences a relatively large pullback as a result of the Fed’s small rate cut, it may be sensible for investors to consider re-entering the markets after it stabilizes.

“If they do a one and done, if they do one 25 basis point cut or they do 50 but they don’t do three to five 25 basis point cuts, I think it would be actually a good time to get in when you do see that retracement in markets,” she said.

What comes next?

With the Dow Jones and S&P 500 having reached record highs in 2019, investors clearly anticipated throughout the past eight months that a few cuts are likely to be planned by the Fed.

Fed Chairman Jerome Powell, by characterizing the rate cut as a “mid-cycle adjustment,” diminished hopes of multiple cuts by the year’s end.

Zhiwei Ren, Penn Mutual Asset Management portfolio manager, told Bloomberg that the one and done rate cut of the Fed came as a surprise but it is accommodating enough, for now.

“The market pricing is for three more cuts for the next one year. He is pushing back that market pricing. He says this is a mid-cycle rate cut, which means it is one-two cuts and done…he is not giving the market what it wants – three cuts for next year. He basically said ‘At the beginning of the year, we were pricing a few hikes and turned patient – no rate hike, no cut – and now we’re cutting 25 bps. We think that’s accommodative enough.’ he didn’t say they need to cut more. That’s a big surprise to me and the market,” he said.

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