Central-bank rate cuts can sometimes alarm rather than reassure investors, as recent events involving the People’s Bank of China (PBOC) and former New York Fed President William Dudley have demonstrated.
On Thursday, the PBOC surprised markets by cutting its medium-term lending facility (MLF) rate to 2.3% from 2.5%. This move followed an unexpected reduction in the seven-day reverse-repo rate earlier in the week, raising fears about the strength of China’s economy.
“This is the second cut this week, signaling concern from Chinese authorities about the state of their economy, which is worrying for stock markets and investors,” noted Kathleen Brooks, research director at XTB.
Context is crucial. Rate cuts can boost stocks and risky assets if perceived as preemptive measures to prevent an economic downturn. This expectation has fueled U.S. stock rallies since last fall as investors anticipated Fed rate cuts that have yet to materialize.
However, when a central bank cuts rates due to economic deterioration, investors can become unsettled. This was evident on Wednesday when U.S. stocks had their worst day since 2022. Poor earnings from Alphabet Inc. and Tesla Inc. contributed, but Dudley’s reversal on rate policy also caused concern.
After advocating for prolonged high rates, Dudley cited weakening economic data as a reason to support immediate rate cuts in his Bloomberg column. This shift, coupled with other factors, led the tech-heavy Nasdaq Composite to fall 3.6%, the S&P 500 to drop 2.3%, and the Dow Jones Industrial Average to lose over 500 points.
These events, combined with poor European purchasing-manager index readings and Dudley’s comments, prompted investors to offload risky assets. Despite the tumult, bullish investors argue that the selloff was primarily driven by weak tech earnings and an adjustment from overly optimistic positions.
Expectations for a July rate cut by the Fed remained relatively stable, with Fed-funds futures traders pricing in a roughly 9% probability, according to the CME FedWatch Tool.
Tom Essaye, founder of Sevens Report Research, emphasized the need to monitor growth closely: “None of this pullback includes growth worries. I am still concerned about growth, and Dudley’s comments make me more nervous. We need to watch growth very closely.”
In summary, recent market reactions highlight that rate cuts aren’t always reassuring, especially when they signal underlying economic weaknesses. Investors remain wary, closely watching economic indicators and central bank actions.
