Another Fed Rate Cut

The FOMC cut the target Fed Funds Rate to 2.00% as was widely expected today

Trader's Playbook

FOMC Announcement October 31st, 2:15pm EST

A 25 basis point cut is already factored into the US Equity markets and into the US Dollar. In fact, the USD seems to have a total of 50 basis points cut by yearend factored in.

Scenario 1: Fed Cuts 25 Basis Points

US Equities rally and the USD sells off a bit. No real news here since this cut is already taken for granted by traders. But with a total of 100 basis points cut expected from Sept to Dec of this year, is the US Economy really OK? Large Cap US Equities (Dow Jones Industrial Average) are still strong because they get so much profit from overseas business and all that foreign revenue, when brought back into the US (with lower USD levels), means increased accounting profits. However, Small Cap US Equities (Russell 2000 or S&P Small Cap Index) companies are facing a slowing US Economy and a scared US consumer just as the biggest retail season of the year hits.

The Play: To stay neutral on overall US Equity market, we buy Large Cap ETF and sell Small Cap ETF. USD goes lower taking out technical levels in EUR/USD and GBP/USD on the topside. This will be a quick, short move. USD goes gradually lower vs. JPY in a longer-lasting move.

Scenario 2: Fed Cuts 50 Basis Points

US Equities rally briefly and then fall over next few weeks. A 50 Basis Point Cut from the Fed means the US economy is in real trouble. The USD falls and gains momentum to the downside across all currency pairs. BIG TROUBLE. Highly unlikely scenario

The Play: If any rally in US Equities, buy out of the money puts on US indices for DEC or JAN expiration. USD will gap lower. Do not chase the initial move. You will have your chance to sell the USD; it has a long way to fall.

Scenario 3: No Cut By FOMC / Statement Mentions Inflation

Gonna be a long day if this scenario unfolds. We see this as more likely than a 50 BP cut, but still unlikely. This would be sending a mixed message to traders; the previous 50 BP cut tells the world that the Fed is worried about the US economy slowing mainly due to construction and financial services sector slowdowns. No action by the Fed this time states that the Fed is caught in a bind with slowing US growth and inflation worries ahead of us. This would be bad news. Anyone remember the 1970’s and the word stagflation?!?! US Equities will immediately crater with the DJIA off at least 2% on the day. Gold will go above the $800 level. The USD will have a sharp retraction to the positive side and take out the “weak hands” in the market.

The Play: We expect parabolic increasing demand for USD as anyone who got into the short-USD rally late has to buy them back, and there are a lot of short USD speculators out there. CFTC data shows a record number of short USD positions held by speculators. We sell EUR/USD and expect the downward move will last for days if not weeks. GBP/USD will fall hard but not as prolonged as EUR/USD. Carry trades caught in between two fundamental forces. Risk aversion means a sell-off in the carry trade, but increasing expectations of inflation means fundamentally the carry trade is in better shape than ever. Watch for a push lower and buy on dips.