Market Reaction to Fed Rate Cut: Sell-Off and Rising Inflation Concerns

Let's start with what happened to markets after the Fed's rate cut yesterday. It wasn't pretty. The Dow dropped 1,100 points. The S&P fell 3%. The Nasdaq dropped 3.5%. The Russell 2000 small-caps fell 4.4%. And the 10-year yield surged, pushing mortgage rates back above 7% today. Why such a bad reaction to a rate cut? It wasn't the cut itself. It was the Fed's updated projections on future rate cuts. They're now expecting, on average, just two more cuts next year.

The market was still expecting three. Boom! There's your selloff.Both growth and inflation have come in firmer than expected since the Fed's half-point cut back in September. As a result, the 10-year Treasury yield has risen from 3.6% before that rate cut to 4.56% as of this morning. The'good' news is that's un-inverted the yield curve, a promising sign for banks to do more lending and support the economy into next year. But there is plenty of not-so-good news about this, too. For one, no one wants stickier inflation. The 10-year'TIPS' yield, an inflation proxy, has been spiking in recent days, and especially after the Fed's rate cut yesterday. It's gone from 1.9% two weeks ago, to 2.22% this morning. It's only been higher twice in recent years; earlier this summer, and in late 2023.When inflation expectations spike, it's a headwind for the broader market, as Barry Knapp of Ironsides Macro explains. It tends to favor outperformance of the'Mag 7,' or any mega-cap tech stocks, over the rest of the market. It's why the equal-weight S&P 500 has been lagging of late. It's why the Russells did so poorly yesterday.And then there's the fiscal problem. High rates are, to put it mildly, a disaster for the budget. Recall, $900 billion of our $1.8 trillion deficit last year went to interest payments on the debt. Because we can't cancel the debt, the only way to lessen that figure (and to stop adding to the $36 trillion debt pile) is to bring rates down meaningfully. That's clearly not happening right no

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