We live in a world where central banks wield ultimate power over the stock markets.
Their rate policies have influenced every single move of the last decade, including in each case the direction and strength.
Today, the most powerful central bank in the world, the Fed, will once again demonstrate this dominance.
At 14:00 ET, Jerome Powell will announce the much-anticipated rate decision… and it will have a pronounced effect on markets worldwide.
Let me explain why.
The Inner Mechanics Of The Current U.S. Economy
Typically, lower interest rates make it cheaper for companies to take on debt. They can then use it to expand their operations, which stimulates the economy.
However, today’s rate cut won’t achieve that purpose.
Companies have indeed stopped spending on new projects. But it’s not because debt would be too expensive. It is because the trade war issue is still unresolved.
GDP figures are falling around the world, supply routes are changing, and there is increasing political instability. It is hard for any business to commit and expand in the face of so much uncertainty.
So this rate cut won’t help the economy one bit. The only beneficiary will be the stock market.
Corporations will use the freshly-available cheap credit for share buybacks. This has been their common practice since the last recession. It is also the main reason why the stock market has inflated so much.
The Stock Market’s Dominance Over Fed Policy Decisions
It’s a serious shame to see the Fed wasting its recession-fighting tools so unnecessarily.
However, we have found ourselves in a situation where the stock market is forcing its hand.
“Either cut, or I will crash…” That is the clear message.
The real problem is that, if the stock market crashes, so will Trump’s economy’s last support pillar, consumer spending, which would inevitably trigger a recession.
Unfortunately, chances of the Fed keeping rates where they are have risen substantially over the last week.
Current estimates predict chances of this happening at 34%. Just a week ago, chances were estimated at 7.7%. A month ago, odds were zero.
With the current Fed board divided as it is on the rate policy, the reality is chances right now could be even higher than 34%.
If that is the case and interest rates stay the same, I suggest you load up on defensive stocks such as utilities, consumer staples, health care, and gold miners.
The most likely outcome, however, with a 66% chance, is another 25-basis point rate cut. That way, the Fed can have its cake and eat it, too.
The market is pricing this in, so any rally won’t be as pronounced. If that happens, I suggest you stick with what’s been working so far—a balanced portfolio of quality stocks with little exposure to the ongoing trade war.
Of course, the ideal situation for the market would be a 50-basis point rate cut. But while the chances of this event were 22% a month ago, today they have fallen to 0%.
That said, you should always prepare a strategy for every outcome, no matter how unlikely.
If the Fed surprises everyone today with a 50-basis point rate cut, I suggest you go on the offensive. The market is bound to reach new highs. Load up on consumer cyclicals, financials, industrials, and the more cyclical tech stocks such as semiconductors.