I was online with some of my team members last Wednesday while the Fed was announcing a 25-basis-point cut to the Fed funds target rate.
As usual, the conversation was lighthearted, but I got thought-provoking questions: What did I think about the fact that central banks all around the world were pumping stimulus into their economies at essentially the same time? Are we getting set up for a global smackdown as some of the market preppers are suggesting?
A story came right to mind. With this much cheap money flooding global markets again, some things are going to change...
Cheap Money Becomes Expensive Debt
Around 44 million Americans owe about $1.5 trillion in outstanding student debt. They're really racking it up. Students (and in many cases, parents and even grandparents) are hamstrung for decades after their graduation.
This causes a kind of butterfly effect that's going to ripple through generations.
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I remember the days as a young freshman when we would walk through the Oval at Ohio State. We'd be greeted by goodie bags of free t-shirts, Frisbees, and other tchotchkes that would (mostly) wind up in the garbage. Just about everything in those goodie bags was tied to a credit card application for a "great introductory rate" that was "perfect for young college students."
You know the kind I mean - you stay ahead of the payments for the first six months, then maybe you start to accumulate a balance and pay the monthly minimum to try and get it back under control. Of course, two years later, most students are carrying a balance in the thousands with a rate that continues to creep higher. Paying the minimum guarantees that debt sticks with you for, well, generations.
The point is cheap money costs plenty over the long run, and it feels like central banks from New York to Tokyo are taking that walk through the Oval picking up a bunch of credit tchotchkes.
The irony is that we have legislators and presidential candidates that are trying to put together plans to forgive college debts because it's become almost impossible to get out from under the burden! This is at the same time that the Fed and other big central banks are helping to facilitate the same situation at a macro level.
So what's this have to do with the markets?
A lot... Cheap money can buy short- and intermediate-term market gains at the expense of long-term economic health.
Here's what I think is happening.
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These Rate Cuts Could Mean a Change for the Market
The market's reaction to the Fed's action was spot-on over the first fifteen minutes. Stocks fell as traders and investors digested the implication that there wouldn't be any more rate cuts in the near term; as it turned out, the Fed changed a few words around in its press release.
Then, Chairman Powell calmed things down by explaining that the Fed was still ready to act if needed to lower rates.
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POW! Off went the market - like a shot. All of the sudden traders and the quant models that picked up on the dovish language figured out that there's at least a theoretical chance we could get more rate cuts.
My point? That reassurance that we could see lower rates is similar to the guarantee on the box that is making the market feel warm and toasty because the "Guarantee Fairy" may leave another quarter-percent rate cut under everyone's pillow.
Clearly, I'm oversimplifying things here, but there's a trend that is relative to this story. Historically, when the Fed cuts rates more than three times, we tend to see markets make long-term tops. This makes intuitive sense, as the Fed really only needs to cut rates for a long period when the economy is preparing to trip.
Interestingly, the Fed's target rates were at 6% and 5.25% respectively the last two times they started a rate-lowering cycle in 2000 and 2007.
But this time around, rates started at 2.5%. That means the Fed has half the stimulative "ammo" this time around before we get to 0%. I personally hope that the Fed tries to keep some of its powder dry in case this battle is longer than expected.
Bottom line: Despite the enthusiastic, albeit slightly delayed reaction we got to Wednesday's announcement, continued rate cuts aren't really something to celebrate - I don't think we're at the start of another decade-long bull run.
Instead, these rate cuts are telling us to prepare for a changing market - and a changing economy. They're telling you to add some cheap protective puts while building a modestly bullish trading stance.
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About the Author
Chris Johnson (“CJ”), a seasoned equity and options analyst with nearly 30 years of experience, is celebrated for his quantitative expertise in quantifying investors’ sentiment to navigate Wall Street with a deeply rooted technical and contrarian trading style.