- The Dow Jones is set to open with a steep drop after a 0.8% slip last Friday.
- Major central banks including the Fed and ECB are hinting at additional rate cuts.
- Markets are not pricing in an additional rate cut in 2020, and it could catalyze the stock market.
Amidst an ongoing crisis in the Middle East, the Dow Jones Industrial Average (DJIA) futures indicate a steep 136-point drop at Monday’s open. But, major central banks are already starting to hint at further interest rate cuts, which would catalyze the momentum of the U.S. stock market.
Nikkei 225 index of Japan and South Korea’s KOSPI fell by 1.91% and 1% respectively on the day, adding to the gloomy sentiment of the global stock market.
Dow Jones is vulnerable but a new rate cut changes things
Even before the conflict between the U.S. and Iran intensified, analysts predicted a rough start for the Dow Jones in 2020.
The Dow ended 2019 with 22% gain bolstered by strong performances from Apple and Microsoft. The magnitude of the rally led strategists to anticipate a steep pullback for the Dow Jones in the first quarter of 2020.
Iran’s nuclear deal pull-out and rising geopolitical risks as a direct result of the dispute in the Middle East has made the Dow Jones more vulnerable to a correction in the first half of the year.
However, the market has been pricing in a full 12 months in 2019 without a rate cut based on futures data from CME. Hence, if the Federal Reserve initiates a rate cut as hinted by Federal Reserve Bank of New York President John Williams, it would act as a short-term catalyst for the Dow.
Williams said at the American Economic Association’s annual meeting that policy makers were forced to accept declining interest rates due to “many stages of grief.”
European Central Bank chief economist Philip Lane also said that the possibility of an additional rate cut cannot be ruled out.
Why fear of a bigger correction is increasing
The Dow Jones already dropped 233.92 points on Friday and closed with a 0.81% drop. The U.S. stock market could contract by as much as 2% on a two-day span.
Iran’s relationship with the U.S. has consistently been rocky throughout the last two years. It is difficult to state that the Middle East crisis is the sole factor for the decline in the U.S. equities market since last week.
Rather, economists explain that the way the U.S. handled the Iran situation has led investors to re-evaluate the rally the Dow Jones demonstrated since mid-2019. It may also lead the market to rethink the stability in trade talks, which has been a major driving factor of the bull run.
All of the foundations that triggered a U.S. stock market rally in 2019 are still existent: relaxed financial conditions, a low interest rate, and a trade deal with China. But, investors are showing concerns about the unpredictability of the Trump administration regarding foreign policies and trade-related activities.
Certain technical indicators are also eerily reflecting levels unseen since 2009, when the Great Recession was just coming to an end.