Federal Funds Rate: Decisions And Discussion

The Federal Reserve will be meeting this Wednesday, October 30, 2019. They will be issuing a decision about their desired Federal Funds rate and guidance about the likelihood for future rate cuts.

Investors should be prepared for the market reaction to both the cut and the guidance. Fortunately for investors, that can be simplified into a 4-outcome decision box. If investors can estimate the probabilities of cut vs. no cut, and future cuts vs. one and done, that creates 4 scenarios with associated likelihoods. Investors then can anticipate the potential market move that might result from each of the 4 scenarios. At that point, one can estimate blended outcomes for each of the potential scenarios.

The spreadsheet below should make that explanation more observable:

(Click on image to enlarge)

In this example, I used the current 90% probability of a 25 basis point (1/4%) cut that is implied by futures markets. The guidance probabilities require much more of a judgment call. My best guess is that the markets expect a 60% chance that the Fed will indicate that they will pause after cutting rates this week, as futures markets imply a 40% chance of another rate cut in the coming 6 months. 

I have far less confidence in the expected market reaction to the various scenarios. I believe that a decision to keep rates unchanged will be greeted as a negative under any circumstances. Markets don’t like surprises, and a decision that deviates from consensus could be unwelcome. The magnitude of that disappointment is an open question. I also must wonder whether simply meeting consensus would create a buy the rumor, sell the news event. My gut says yes, though I may be pricing in too much negativity. 

The market may have room for positivity if the Fed cuts rates and keeps an easing tone.  Much will depend on various nuances if that occurs. A too dire outlook could spook the markets, though a relatively rosy outlook accompanied by a friendly monetary backdrop could inspire more enthusiasm for stocks.

My suggestion would be to use the spreadsheet as a guide and update the market reaction boxes with your own best estimates. My estimates are speculative and subject to change even under the best of circumstances. 

Hopefully, this will provide you with some direction as we enter a few days of extreme uncertainty.