Markets Cheer Lower Interest Rate Outlook

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Market Moves 

Wednesday marked the first day of Federal Reserve Chair Jerome Powell's congressional testimony, and he didn't disappoint. Powell all but confirmed the expected Fed rate cut in late July and also helped increase bets that the cut could be more substantial than previously thought.

Investors in both stocks and gold cheered Powell's dovish-leaning testimony, while the U.S. dollar slipped, as might have been expected. The Nasdaq Composite did especially well among the major stock indexes as big tech names surged.

Prior to Powell's first day of testimony, markets had been in a holding pattern and generally pressured off of new record highs. During the Fed Chair's appearance in front of the House Financial Services Committee, the S&P 500 tentatively crossed above the crucial 3,000 milestone, hitting a new intraday all-time high before pulling back. The Nasdaq Composite and Dow Jones Industrial Average also hit new intraday record highs during his testimony.

Among Powell's dovish comments, he claimed that the better-than-expected jobs report last week was "about as expected" and didn't affect the Fed's interest rate and economic outlook. He added that "manufacturing, trade, and investment are weak all around the world." Powell further stated that "uncertainties around global growth and trade continue to weigh on the outlook" and that "inflation continues to be muted."

All of this points rather unambiguously to one thing – lower interest rates, and perhaps even lower than previously expected. Shortly after Powell's testimony concluded, the CME Group's FedWatch tool showed the market probability of any rate cut this month at 100%. While this was the same as the day before, there's now a full 26% probability of a 50-basis-point rate cut instead of a 25-basis-point cut. A day earlier, there was only a 3% chance of a 50-basis-point cut.

Chart showing target rate probabilities for July Fed meeting
CME Group

The minutes from June's Federal Open Market Committee (FOMC) meeting were also released on Wednesday, revealing that some members thought "a near-term cut in the target range for the federal funds rate could help cushion the effects of possible future adverse shocks to the economy." Although the Fed did not take any decisive steps toward a rate cut in June, it was clear that members were building a case for lower rates in subsequent months.

Nasdaq Composite Breaks Out Above Double Top Pattern

As noted above, all three major large-cap indexes – the Dow, S&P 500, and Nasdaq Composite – broke out to new highs on the increasing prospect of lower interest rates from the Fed. Lower interest rate environments generally result in higher stock prices, as declining rates help boost spending and decrease borrowing costs for companies.

The tech-heavy Nasdaq Composite had the biggest boost from Powell's testimony on a percentage basis among the major indexes as tech stocks surged. As shown on the chart, last week saw the index form what could have turned into a bearish double top pattern around the 8,170 resistance area. Instead, we're now seeing a bullish breakout above that double top resistance.

While still tentative, the breakout is a major technical move. This move could be confirmed as early as Thursday when Powell testifies for a second day, this time in front of the Senate Banking Committee. Any continued Fed-driven momentum this week could result in significantly further upside into record territory for the Nasdaq Composite.

Chart showing the performance of the Nasdaq Composite Index

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Gold Pushes Higher on Rate Cut Expectations

Stock investors were not the only ones to benefit on Wednesday from the increased prospect of lower interest rates. Having rallied sharply since late May, the price of gold also saw a nice surge on Wednesday. When interest rates are expected to fall, non-interest-bearing gold has less competition from interest-bearing instruments. As a result, demand for gold, and gold prices, tend to rise. This is what we're currently seeing with the precious metal as the Fed has become increasingly dovish of late.

As shown on the chart, the price of gold futures has been in consolidation since late June as the Fed's path has been in question. Overall, though, gold remains in a sharp uptrend that accelerated in late May as the Fed began to drop more and more dovish hints.

From a technical perspective, gold appears to be forming a flag/pennant pattern, usually considered a trend continuation formation. If the Fed stays on a rate-cutting path, gold prices could be boosted further after a potential upside pattern breakout.

Chart showing the performance of gold prices

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U.S. Dollar Stumbles on Dovish Fed Policy

As one might expect when there's a greater chance of lower interest rates in the near future, the U.S. dollar dropped in value against other major currencies on Wednesday. Generally speaking, currencies have a positive correlation with interest rates. In the currency market, when all other factors are kept constant, money flows toward currencies that are higher yielding and away from currencies that are lower yielding. This is the basis for the currency carry trade.

The U.S. dollar index is a primary benchmark for the U.S. dollar, as it measures the value of the dollar against a basket of other major currencies, including the euro, Japanese yen, British pound, Canadian dollar, Swedish krona, and Swiss franc.

As shown on the chart, the dollar index fell on Wednesday. With any further dovishness from the Fed, the dollar is likely to fall further. From a longer-term perspective, the index is still in an uptrend, although its upside momentum has been waning of late. Currently, the dollar index has fallen back below its 50-day moving average. Any further drop below the 200-day moving average could signal a change in trend to the downside, especially if the Fed extends rate cuts further.

Chart showing the performance of the U.S. dollar index

The Bottom Line

Fed Chair Powell's time in the spotlight is not over yet. His Senate testimony is scheduled for Thursday. While investors will likely receive very similar information from the Senate testimony as they did from Wednesday's House testimony, there's a strong chance that different innuendos will emerge in reaction to questions from senators.

Also on tap for Thursday are key U.S. inflation numbers in the form of the Consumer Price Index (CPI). Since inflation is a key aspect of Fed rate-setting, this could play a critical role in the Fed's path.

Get ready for more rate-driven market moves ahead.

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