S&P 500 Goes On Volatile Ride With Fed Rate Cut Timing At Stake

Posted: May 20, 2019 9:44 AM

The S&P 500 (Index: SPX) experienced an interesting level of volatility during the third week of May 2019, as investors shifted how far forward in time they're looking into the future twice during the week. 

We consider an "interesting level of volatility" as being whenever the closing daily value of stock prices changes by more than 2% from the previous trading day's closing value, for statistical reasons, where the action on Monday, 13 May 2019 definitely qualified as such. As it happens, we were uniquely positioned to analyze the event, where we provided special coverage for it since the change in stock prices was accompanied by a change in investor expectations for the future, which prompted investors to shift how far forward into the future they were looking.

The quick summary of what happened on Monday, 13 May 2019 is that investors shifted their forward-looking focus from the distant future quarter of 2020-Q1 back toward the nearer-term future of 2019-Q4. Because several Federal Reserve officials had been communicating that it would cut interest rates if U.S. economic growth looked like it might suffer from the U.S.-China trade war, China's weekend announcement that it would launch new retaliatory tariffs against U.S. goods sharply increased the probability that the Fed would cut rates in or by 2019-Q4, which prompted investors to shift a portion of their forward-looking focus from 2020-Q1 to 2019-Q4. The rest can be explained simply by the math behind how stock prices work.

Picking up from that point, chart above reveals that investors next shifted their forward-looking attention back toward 2020-Q1, which was prompted by new information related to the strength of the U.S. economy, an easing of trade war-related worries, and a statement by a Fed official that they saw no need to change U.S. interest rates at this time.

By Thursday, 16 May 2019, the flow of news was such that investors had shifted their forward-looking attention back toward 2020-Q1 more fully, where the S&P 500 went on to end the week within the range of values our dividend futures-based model indicates would apply for when investors are largely focused on that future quarter.

That occurred even though investors are still placing better-than-even odds the Fed will cut interest rates well before the end of 2019, according to the CME Group's FedWatch Tool, where the probabilities table indicates investors are pushing out their expectations for the timing of a Fed rate cut to occur later than what they were betting the future would be on Monday, 13 March 2019. Here's the picture of those probabilities as of the close of trading on Friday, 19 May 2019.

We can reasonably expect interesting levels of volatility in stock prices to continue while investors shift their attention back and forth between these two future periods of time as the timing of the Fed's next interest rate move is at stake. And though these kinds of dynamics mystify former Treasury secretaries who labor under Keynes' antiquated animal spirits-based pagan belief system, they're really all you need to understand why stock prices have been behaving as they have at this time.

Here's our wrap-up of the major market-moving headlines from the trading week ending on 17 May 2019.

Monday, 13 May 2019
Tuesday, 14 May 2019
Wednesday, 15 May 2019
Thursday, 16 May 2019
Friday, 17 May 2019

There were more U.S. markets and economy news than that during the week that was, which Barry Ritholtz categorized into seven positives and seven negatives.