US stocks closed higher on Friday, capping a strong week fuelled by renewed optimism about a potential Federal Reserve interest rate cut. 

The S&P 500, Nasdaq Composite, and Dow Jones Industrial Average all posted gains, marking a significant rebound from recent market volatility.

Nasdaq Leads the Rally: Best Weekly Performance of the Year 

The Nasdaq led the way, surging over 5% for the week, its best performance of the year. 

Investors were encouraged by growing expectations for a more aggressive rate cut at the Fed’s upcoming meeting. 

Traders are now pricing in a nearly 50% chance of a half-point reduction, up from just 15% earlier in the week.

Market Sentiment Shifts

This shift in sentiment follows reports suggesting that the Fed’s decision on the size of the rate cut may be a close call.

Additionally, influential former Fed official Bill Dudley has argued for a more substantial reduction.

The yield on the 10-year Treasury note declined slightly on Friday, reflecting the market’s anticipation of a rate cut.

Economic Slowdown Concerns Persist

While the recent rally has been driven by optimism about monetary policy, concerns about a potential economic slowdown and the labor market remain. 

Analysts warn that the market’s volatility could persist, especially if the Fed opts for a smaller rate cut than anticipated.

For the week, the S&P surged +4.0%, while the Nasdaq Composite jumped +6.0%. The blue-chip Dow climbed +2.6%.

Weekly Market Recap 

For the week: 

• S&P 500: +4.0% 

• Nasdaq Composite: +6.0% 

• Dow Jones: +2.6% 

Friday’s Closing levels: 

The Big Question: 25 or 50 Basis Points? 

It is all going to boil down to whether the Fed moves by 50 basis points or 25.

The Market is telling the Fed it wants 50. The Fed might give them what they want.

While this is always a possibility, it may cause the Fed to look bad.

Case for a Conservative 25 Basis Point Cut

These are the reasons why they should go 25 basis points only.

First, the US labor market is not falling out of bed. Second, US consumer spending is resilient. Third, underlying inflation is sticky. Fourth, financial conditions are loose.

The Fed has always indicated a low and steady response to financial conditions. Going 50 would indicate a more rapid response and would put them at an awkward position if inflation were to come back.

These are the reasons why they should go 25 basis points only.

Key Indicators: Labor Market and Inflation Hold the Key

First, the US labor market is not falling out of bed. Second, US consumer spending is resilient. Third, underlying inflation is sticky. Fourth, financial conditions are loose.

The Fed has always indicated a low and steady response to financial conditions. Going 50 would indicate a more rapid response and would put them at an awkward position if inflation were to come back.

Market Implications: What Could Happen After the Fed’s Decision? 

So, the market has placed itself in a position of high risk. If the Fed goes 50 basis points as the market expects, then we may see a test to new highs in the S&P, however if its only 25, there could be a scenario where the disappointment causes a selloff that could get ugly.

I think 25 is what the Fed will do. If it causes the market to selloff there is always the dip buyers that may come in to prevent a crash.

Source: CBOE, Bloomberg 

This commentary is written by James Gomes, a seasoned finance industry veteran with extensive experience of over 30 years, including a substantial tenure at a reputable US bank exceeding 20 years. 

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