Fed Rate Cut: Words Speak Louder than Actions and the Importance of Signalling Mechanism

The conventional wisdom says that it is the actions which matter more than words. Unless you are backing your words with tangible action on the ground, your words are completely hollow and no one will take mere words seriously. However, the last day of July was different from that perspective. It was a big event as the Federal Reserve cut interest rates for the first time in more than a decade. True, the move was widely expected and you may even argue that it was in the price. However, the market reaction to the rate cut was still unexpected as if the rate cut didn’t happen at all.

Fed’s first rate cut since it slashed rates to near zero in 2008 disappointed the markets because Fed Chairman didn’t make any attempt whatsoever to signal the beginning of an aggressive rate-cutting campaign. Some of the more optimistic market analysts were also expecting that the cut will be a little deeper that what Fed has announced. Irrespective of the reasons of market’s disappointment, the message was unambiguously clear. By the end of the day, the S&P 500 was down 1.1 percent and markets across the world are also under pressure.

There are three important take away from the market reaction and the most important is that more you feed the market; more it will need. Market didn’t look at directional shift and precautionary measure of rate cut by Fed (compared to this, 2008 and everything around Global Financial Crisis was a remedial effort) which in itself is a welcome move, but also the fact that Fed is clearly keeping an eye on possible disruptions in global linkages of US economy. The only thing market focused on was that it didn’t get what it wanted i.e. a firm assurance on more rate cuts in next twelve months.

The other important message from market reaction is that we strongly believe that market is clearly in great need of external stimulus and that is not good news from the perspective of fundamentals. If market is disappointed that further rate cuts by Fed may not happen, one interpretation is that market does expect a further deterioration in macro environment which will necessitate these rate cuts. The important issue is that while rate cuts would help the economy and the markets in US surely, the dependence on these moves over short to medium term seems on the higher side, this is not a bright situation as such.

Finally, this market reaction can also be seen as an end result which didn’t achieve the desired objective for Fed. If Fed’s idea was to soothe the nerves for market participants, it didn’t work. Clearly it is very difficult to believe or even imagine that if there are negative developments in CY19 and CY20 such as a worsening trade war between US and China or more serious geopolitical conflicts, Fed will remain a mute spectator. In that case, markets may have clearly overreacted but Fed will have to share the blame to some extent for that.

A Fed Rate Cut which is first in more than ten years and the market reaction which followed was clearly the case when Fed’s words spoke louder than its actions instead of Fed’s actions speaking louder than its words. Market would be sincerely hoping that Fed doesn’t stick to its plan on rates and become further more accommodative.

Research Team
EM Alpha LLC

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EMAlpha, a data analytics and investment management firm focused on making Emerging Markets (EMs) accessible to global investors and unlocking EM investing using machines. EMAlpha’s focus is on Unstructured Data as the EMs are particularly susceptible to swings in news flow driven investor sentiment. We use thoroughly researched machine learning tools to track evolving sentiment specifically towards EMs and EMAlpha pays special attention to the timely measurement of news sentiment for investors as these markets can be finicky and sentiment can be capricious.Our team members have deep expertise in research and trading in multiple Emerging Markets and EMAlpha’s collaborative approach to combining machine learning tools with a fundamental approach help us understand these markets better.

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