Fed-Driven Roller Coaster

Market Moves 

When the Fed's rate decision and FOMC statement were first released on Wednesday afternoon, markets just yawned. The 0.25% rate cut that the Fed announced was widely anticipated, and the door was indeed kept open for further possible rate cuts later this year – also as expected. In cutting the federal funds rate, the central bank cited global economic outlook risks and lagging inflation. Again, no surprises there.

It wasn't until the scheduled press conference that the market drama really began. During the course of the press conference, Fed Chair Jerome Powell characterized the rate cut as a "mid-cycle adjustment to policy." Powell went on to say that he was "contrasting it there with the beginning of a lengthy cutting cycle." In other words, he was suggesting that Wednesday's rate cut was a simple interest rate adjustment, and not necessarily the start of a new trend in lower rates.

This was not taken well by stock investors, who swiftly began to dump stocks. Prior to the decision and press conference, investors had generally been hoping for either a larger rate cut or at least language that would suggest an aggressive pace of rate cuts going forward. They got neither of these. A sharp sell-off ensued after markets interpreted Powell's comments as much less than dovish.

As shown on the chart of the S&P 500, the benchmark index dropped more than 1%, which was the worst drop since May. The low of the daily candle was around key support in the 2,960 price region. This places the index at a critical juncture. If support can hold going forward, we could be seeing a rebound and recovery, potentially to new record highs. But if this support is ultimately breached, a significantly further pullback would be likely.

Dollar Breaks Out on Less Dovish Outlook

As stocks tanked on a Fed outlook that was less dovish than expected, the U.S. dollar surged. Generally speaking, currencies have a positive correlation with interest rates. When all other factors are kept constant, money flows toward currencies that are higher yielding and away from currencies that are lower yielding. While it's true that a Fed rate cut should pressure the dollar, the surprise on Wednesday was that the Fed may not be looking to begin a substantial rate-cutting cycle, which helped boost the dollar.

As shown on the chart of the euro vs. the U.S. dollar (EUR/USD), the currency pair hit a new low not seen since May 2017. Another way to look at it is that the dollar has hit a new 26-month high against the euro. This was a key breakout move for the dollar although still tentative for the time being. With any further follow-through on the EUR/USD breakdown, the next major downside target is around the 1.0900 level.

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Semis Pull Back Hard

Finally, let's take a look at the semiconductor stocks, one of the hottest sectors since early June. The VanEck Vectors Semiconductor ETF (SMH), an exchange-traded fund (ETF) holding some of the largest companies in the industry, hit a new record high exactly one week ago. Since then, though, it's been pulling back sharply.

On Wednesday, the market's interpretation of the Fed Chair's comments accelerated the decline of semiconductor stocks, which may have been hit by a double-whammy of 1) no clear path to lower interest rates, and 2) very little progress on U.S.-China trade talks.

As shown on the chart of SMH, price has pulled back to a key uptrend support line extending back to the early June low. While the ETF is still trading within a strong uptrend, any major breakdown below the trendline could signal a sharper pullback from all-time highs.

The Bottom Line

The big Fed event came and went, and markets were indeed affected in a major way. As usual, nuances and interpretations of the Fed's words were able to move markets significantly. Whether these moves endure and extend is the next question. Wednesday could have been just the catalyst needed to trigger profit-taking and a sell-off that results in a much deeper pullback from new record highs. Or, the markets may soon just shrug off the Fed's fickle, wait-and-see approach. We'll know more in the next few days, but we're leaning toward the latter.

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