Hello,
Ive developed a big interest in the market and economics and the recent development leaves me slightly confused. As I understood markets rallied over the past month off of inflation data coming down and potential interest rate cuts.
Obviously lots of data with ppi, CPi, Jobless etc PP.
Furthermore ratecuts meant (usually) more spending both in private as well as business sector. Now markets anticipate a 50bps cut and sold off hard fearing recession might already be here.
I know that actual cuts in the past led to often mark tops and sold off but my question is:
Why do markets rally in anticipation of rate cuts but now sell off in fear of recession/hard landing.
In: Economics
There’s a very simple maxim of “buy the rumor, sell the news”.
In really simple terms it means people bought anticipating the rate cut and spike in the market and when it happened, sold their position to realize their profit.
There is a fixed pool of money available in the world to invest in different financial products.
Bonds are typically safe products with a low rate of return, while stocks tend to be a risky product with a higher rate of return *on average*.
When interest rates are high, the rate of return of bonds goes up but the risk stays more or less the same. This makes bonds more attractive to buy. Conversely, when interest rates drop, bonds because less attractive.
When a recession is coming, the rate of return on stocks typically decreases while the risk of a loss increases. This makes stocks less attractive to buy.
A belief that interest rates will drop in the future causes people to shift their money from bonds to stocks in the anticipation that bonds will be less value in the future while stocks will be more valuable. This allows them to cash out of the bonds at a high point and buy the stocks at a low point.
The sell off yesterday was because people are worried about a recession based off of unemployment coming up to 4.3% which is higher than what was expected.
The fed has a dual mandate;
1. Keep prices stable at about a 2%-3% inflation rate.
2. Keep unemployment around 4%.
The markets are worried that the fed has kept rates too high for too long and have caused the USA economy to slow too much which will result in a recession.
Most market analysts think this is not the case but the jump in unemployment should signal to the fed that they should cut by at least 50bps by next meeting.
The concern the fed has is that inflation will just start going up again as soon as they cut rates which is what happened under Volker in the 70’s.
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