Sunday, June 16, 2019

What would happen if the Fed cuts rates?

Preface: Explaining our market timing models
We maintain several market timing models, each with differing time horizons. The "Ultimate Market Timing Model" is a long-term market timing model based on the research outlined in our post, Building the ultimate market timing model. This model tends to generate only a handful of signals each decade.

The Trend Model is an asset allocation model which applies trend following principles based on the inputs of global stock and commodity price. This model has a shorter time horizon and tends to turn over about 4-6 times a year. In essence, it seeks to answer the question, "Is the trend in the global economy expansion (bullish) or contraction (bearish)?"

My inner trader uses a trading model, which is a blend of price momentum (is the Trend Model becoming more bullish, or bearish?) and overbought/oversold extremes (don't buy if the trend is overbought, and vice versa). Subscribers receive real-time alerts of model changes, and a hypothetical trading record of the those email alerts are updated weekly here. The hypothetical trading record of the trading model of the real-time alerts that began in March 2016 is shown below.

The latest signals of each model are as follows:
  • Ultimate market timing model: Buy equities*
  • Trend Model signal: Neutral*
  • Trading model: Neutral*
* The performance chart and model readings have been delayed by a week out of respect to our paying subscribers.

Update schedule: I generally update model readings on my site on weekends and tweet mid-week observations at @humblestudent. Subscribers receive real-time alerts of trading model changes, and a hypothetical trading record of the those email alerts is shown here.

An FOMC meeting preview
As we look ahead to the FOMC meeting next week, the market has priced in three quarter-point rate cuts for 2019, with the first cut occurring at the July meeting.

A rate cut is not unexpected, as the bond market has pushed the Treasury yield curve down so far that only the 30-year Treasury bond is trading above the current Fed Funds target. It is likely too early for the Fed to cut rates at its June meeting next week, but if the market is discounting a July cut, the Fed is likely to signal either it is either in agreement with that expectation, or correct the market.

Rather than debate whether the Fed should cut rates, I consider the scenario of what might happen if it were to proceed with a July rate cut. What are the consequences for economic growth, and the stock market? After all, the track record of Fed Funds futures in forecasting the actual trajectory of interest rates has been less than stellar.

The full post can be found here.

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