Last week gave us a taste of just how volatile the stock market can be. The S&P 500 experienced its largest single-week pullback since the financial crisis of 2008.
This week is giving us a taste of just how fickle Wall Street can be when it gets what it wants.
As the stock market kept falling, an increasing number of traders on Wall Street wanted the Federal Reserve to jump in and try to calm market fears by cutting interest rates.
They believed cutting rates would show that the Fed is ready to step in and buoy the U.S. economy, no matter what it takes. They thought it may even act as a sign that other central banks could intervene as well.
Wall Street’s Response
Well, Wall Street got what it wanted on Tuesday. The Fed cut its target for the federal funds rate by 0.5% to a range of 1% to 1.25%. This is the first time the Fed has cut rates between monetary policy meetings since 2008.
Typically, the Fed will announce a rate cut after one of its eight regularly scheduled monetary policy meetings throughout the year. By adhering to this strict schedule, the Fed shows the market it is being calm, deliberate and measured in its monetary policy. However, when negative economic shocks hit, the Fed will make emergency rate cuts like it did on Tuesday.
So how did Wall Street respond when it got what it wanted? It started selling stocks.
You see, the risk of cutting rates like the Fed did is that it confirms that the Fed believes the situation is dire enough to warrant an emergency rate cut, and you never know how traders are going to react when their negative outlook is confirmed.
For traders who believed the current situation was bad enough to warrant a rate cut and that the Fed could help the economy by doing so, the rate cut was good news.
However, not all traders were on the same page. Some wanted a rate cut but were surprised by the timing. Some wanted a rate cut but were surprised by the size of the cut. And some didn’t even believe a rate cut was needed.
When Theory Becomes Reality
It’s easy for traders to have differing opinions when something is still theoretical. But when it becomes real, traders are forced to make a decision and put their money where their mouth is. That collective decision on Tuesday was to sell stocks and buy bonds.
This sent the S&P 500 and the 10-year Treasury yield, as represented by the CBOE 10-year Treasury Note Yield Index (TNX), tumbling lower. In fact, it is the first time the TNX has ever dropped below 1% (see Fig. 1).
Fig. 1 — Monthly Chart of the CBOE 10-year Treasury Note Yield Index (TNX)
The TNX is still drifting lower today, but the S&P 500 has rebounded up off of its Tuesday lows (see Fig. 2).
Fig. 2 — Daily Chart of the S&P 500
This tells us that traders are still concerned about potential declines on Wall Street and are buying Treasurys to protect their portfolios. But they are also willing to put some money back into more defensive stocks at these lower prices.
The fact that the S&P 500 didn’t drop all the way back down to its Friday low of 2,855.84 on Tuesday also tells us that the Fed’s rate cut is having a positive short-term impact.
The Bottom Line
We don’t believe we’ve seen the end of the volatility in the stock market, but it appears a floor has been established for the time being.
If the S&P 500 can close above 3,120 again, there’s hope for a renewed short-term rally. If it remains below this level, watch for more volatile consolidating.
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