All markets, be they equity or fixed income, took a proverbial kick in the shorts on Wednesday. The S&P 500 index finished the day 178.45 points lower (-2.95%), and the Nasdaq index was even hit harder. Longer-term Treasury yields moved higher; the ten-year Treasury note finished the day 0.11% higher in yield at 4.518%. As of this writing on Thursday morning, there was some relief in the equity markets (though not even close to matching Wednesday’s distress), and the ten-year Treasury note continued to ascend to a higher yield level, 4.562%.
So, what happened to cause this distress? A little mathematical visualization might help.
Wednesday’s Distress = [0.25% rate cut by the Fed + A more cautious Fed + Chaos in the House of Representatives] raised to the power of year-end illiquidity
Let’s take each element:
This met market expectations on Monday. The fixed-income market implied a 95.4% probability of a 0.25% rate cut. Expectation met!
The economy has been showing strength going into this Fed meeting. The Atlanta Fed’s estimate of GDP as of December 18, 2024, was 3.2% (not bad). CBS News reported:
“The Federal Reserve on Wednesday announced its third consecutive interest rate cut of 2024, reducing its benchmark rate by 0.25 percentage points amid cooling inflation. Yet in a blow for borrowers, the central bank also projected that it will loosen rates less next year than previously expected.”
Expectations of future Fed rate cuts in 2025 were cut in half, from four to two, and those two are heavily data-dependent.
Late Wednesday, a bipartisan spending bill was killed in the House of Representatives. The deadline for passage and averting a partial government shutdown is midnight Friday, December 19, 2024. The WSJ reported:
“With a 4:15 a.m. ET social-media post on Wednesday, Elon Musk declared that a must-do spending bill “should not pass.” By early evening, the bill was dead, leaving the government barreling toward a weekend shutdown just before Christmas. Lawmakers who might have underestimated Musk’s ability to shake up Washington were suddenly having second thoughts.”
President-elect Trump later called for the defeat of this legislation unless certain provisions were added, like eliminating the debt ceiling (so he could blame the Democrats). One must wonder how long the president-elect will play second fiddle to his consiglieri.
Finally, raise all these factors to the power of increased market illiquidity as we go into the end of the year. As a trader, if you are having a good year, you want to protect it, and if you are having a bad year, you want to hide and forget it. Either way, there is no reason to take risks in front of a holiday.
We get our next read on inflation tomorrow with the release of the US Personal Consumption Expenditure Index. Buckle up, it could be a bumpy ride in either direction.
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