Trading Strategies for 25 or 50 Basis Points Rate Cut | Moomoo Research

The Federal Reserve's latest monetary policy announcement will begin at 2:30 PM Eastern Time on September 18. Currently, the market widely anticipates two possible outcomes for this meeting: either a 25 basis points (BP) rate cut or a 50 basis points (BP) rate cut.

So, what trading strategies can be considered for different rate cut scenarios?

Interest rates play a central role in asset prices, profoundly impacting financial markets much like gravitational pull affects physical objects. The bond market, as an important component of the financial market, is particularly sensitive to changes in interest rates. When expectations for rate cuts intensify, investors typically adjust their investment strategies in advance to adapt to the upcoming interest rate environment. This adjustment is reflected in the fluctuations of bond prices. Due to the inverse relationship between bond prices and yields, expectations of rate cuts enhance the attractiveness of existing bonds, as they offer more favorable coupon rates compared to bonds that may be issued in the future.

The current trading conditions in the market also reflect this expectation. The yield on six-month Treasury bonds has fallen to 4.589%, a decline of 0.50 to 0.75 percentage points relative to the benchmark rate, indicating a strong market expectation for a 50 basis points rate cut. This suggests that the market is optimistic about future rate cuts; however, the disagreement lies in whether the cut will be 50 basis points or 25 basis points.

Imagine you are waiting for a football match, and before the game, someone mentions that it could either end in a draw or one side could win decisively. This is akin to the current market expectation, where the preference for a 25 basis points versus a 50 basis points rate cut is relatively balanced.

If the Federal Reserve only cuts rates by 25 basis points, this decision aligns with one side of the market's expectations, but it may not be the outcome everyone desires. The likely scenario would be:

A slight increase in Treasury yields: Since the market has already anticipated these two possibilities, if the final decision is merely a small cut, Treasury yields may experience a slight upward trend in the short term.

A slight decline in bond prices: Similarly, bond prices may also decrease slightly.

From a long-term perspective, if upcoming data continues to indicate that the economy requires more support, the broader logic is that the Federal Reserve will continue to cut rates. Thus, this small rate cut could provide a favorable buying opportunity for investors. If they are optimistic about a long-term decline in interest rates, they could take advantage of this short-term volatility to position themselves ahead of future rate cuts.

Let's assume the Federal Reserve decides to surprise the market by cutting rates by 50 basis points. This action would also align with one of the market expectations, and the likely outcomes would be:

A decrease in Treasury yields: A substantial rate cut meets or exceeds the expectations of some investors, and Treasury yields may decline further in the short term, reflecting market approval of the Federal Reserve's proactive measures.

Continued rise in Treasury prices: Despite the significant cut, as the market had already anticipated this move, Treasury prices would continue to rise, though the increase is expected to be moderate.

It is evident that if the Federal Reserve opts for a gradual rate cut, the market may see a slight rise in Treasury yields and a small dip in bond prices; conversely, a significant cut would lead to lower yields and a continued rise in Treasury prices—either way, it presents a good opportunity for positioning.

In the current market, investors can choose to directly invest in bond ETFs, such as TLT, EDV, and LQD. Below is a detailed comparison of these options:

For those who prefer to earn interest while betting on price appreciation, EDV is the most suitable option, followed by TLT. For those seeking stability, LQD would be the best choice.

Additionally, investors can consider investing in derivatives of TLT, such as TMF and TMV. These products offer leverage, which can result in higher returns during anticipated market movements, but they also come with greater risks, especially in the case of prolonged volatility, as losses could lead to a depletion of principal. Below is a detailed comparison of TMF and TMV:

In conclusion, the Federal Reserve's interest rate decision will be akin to a "showdown" in the financial world. Whether it is a modest cut of 25 basis points or a significant cut of 50 basis points, it will present a fantastic opportunity for investors to position themselves!