Chief Strategist at Interactive Brokers

There is certainly an optimistic tone to markets today and that optimism is well-justified.  Between positive rumblings on the US-China trade front, progress in Brexit negotiations, and the Federal Reserve extending its purchases of Treasury Bills, today’s news flow has been unrelentingly positive for equities.  There was nary a downtick in the major US indices between the open and the European close.

Yet I have a nagging suspicion that we could be setting up a “buy the rumor, sell the news” event.  The trade deal commentary has been so unrelentingly positive that I worry about the ability for any deal to match the anticipation, especially when that anticipation has been largely fueled via non-specific Presidential tweets.  I have no doubt that there is motivation for some sort of deal – I have said for months that both sides will eventually need to find some common ground that allows President Xi to save face while President Trump can declare a win – but statements prior to the talks seemed to manage expectations for a limited deal.

There is one other self-limiting factor that could come into play – expectations of a Fed Funds rate cut.  Expectations for a ¼ point (25 basis point) cut at the upcoming meeting on October 30 spiked two weeks ago, from about 40% before peaking at about 90% last week.   Since then they have slipped to about 65%.  Today’s announcement of $60 billion in monthly Treasury bill purchases into the second quarter of next year was enacted to stabilize the shaky overnight repo market rather than overtly stimulate the economy.  But I think that the combination of positive trade news and monetary injections would disincentivize the Fed to move once again.  They may want to give their prior moves a chance to take effect before cutting once more.

Markets can and do get it wrong about the Fed.  As recently as May, futures markets were pricing in a near certainty for a Fed hike at the October meeting.  The selloff that we saw earlier this month – which was only recouped today – was arrested when expectations for a rate cut spiked.  Markets could give back some of their recent gains if those expectations ebb further.

I have spent a career managing risk, which has trained me to look for circumstances that could upset the markets’ status quo.  It was for that reason that I recently suggested that nervous investors may want to hedge an upside surprise.  There are many reasons to take good news at face value.  There is also a solid motivation to look for unanticipated risks that may lurk under the surface of news, and especially rumors.

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