The powerful impact of the Fed's significant 50 basis point interest rate cut continues to ferment. Overnight, US stocks rose across the board, igniting 'risk appetite' directly. The Dow and S&P both hit historical highs, with the Nasdaq rising by over 3%, and small-cap stocks achieving seven consecutive increases. In contrast, defensive sectors, which are considered as substitutes for bonds, performed poorly, and long-term bond prices fell.

The key that ignited the market today is a word that appeared up to ten times in Powell's forty-minute press conference—'recalibration'. As 'new bond king' Jeffrey Gundlach mentioned in an interview,

'Recalibration' is the keyword for today.

As the name suggests, 'recalibration' usually refers to adjusting a policy or standard to improve accuracy. According to the market's latest understanding, Powell's interpretation of the 50 basis point rate cut as a 'recalibration' indicates that the Fed is primarily seeking a new neutral interest rate level, rather than using it as an 'emergency measure' to rescue a weak economy in the traditional sense.

A significant interest rate cut with no actual economic weakness can be said to be a scenario that the stock market loves to see. It is only natural to celebrate with a big overnight increase.

However, there are opposing views questioning whether the Fed is using 'recalibration' to conceal the fact that the significant interest rate cut is in response to an economic recession. If the future economy continues to deteriorate, will the Fed choose more aggressive measures such as a 75 basis point rate cut, and still be able to use 'recalibration' as an excuse? Would that not be a loss of credibility?

Affirmative: 'Recalibration' ignites market risk appetite. 'S&P 493' could rise again

On the day of the Fed's interest rate cut, the overall reaction of the US stock market was flat, showing a trend of a high followed by a decline. However, on the next day of the interest rate cut, as investors gained a deeper understanding of Powell's press conference remarks, the market sentiment changed.

Currently, "recalibration" has replaced "restrictive" and rarely mentioned "recession" as the new favorite of the Fed, which has significantly improved risk sentiment. In Powell's press conference, this term was used to describe the Fed's thinking on the future direction of interest rates.

In the opening remarks, Powell mentioned:

The 50 basis point interest rate cut reflects our confidence in maintaining a strong labor market by appropriately "recalibrating" our policies, while achieving moderate economic growth and sustainable decline in inflation to 2%.

When answering questions from reporters about whether interest rates will remain restrictive next year, Powell said:

We know it is time to "recalibrate" our policies to a more appropriate level.

When asked about whether mortgage rates will decrease, he said:

It is time to start "recalibrating" the federal funds rate to a more neutral rather than restrictive level.

Deutsche Bank interpreted in its latest report how to imply policy intentions through "recalibration." According to the report, Powell elaborated on two communication challenges at the press conference: what a 50 basis point rate cut means for the economy and the Fed's reaction mechanism. In response to these two questions, Powell provided a description that avoids sending negative signals to the economy and inhibits market expectations of a rapid decline in neutral interest rates.

Some analysts believe that "recalibration" implies that Powell is hinting at a further interest rate cut in the remaining two meetings this year and the possibility of multiple rate cuts in 2025 and beyond.

Based on the optimistic interpretation mentioned above, some market participants predict that the upward trend in the stock market may no longer be limited to large-cap technology stocks, and the "S&P 493" (493 stocks in the S&P 500 index after excluding the "Big Tech Sisters") may rise again.

Chris Shipley, Co-Chief Investment Officer of Fort Washington Investment Advisors, said that Powell's "recalibration" of interest rates may further drive up small-cap stocks, especially those companies capable of refinancing.

The most interesting part of the market is small-cap stocks...They have more debt and now they may be able to refinance at lower interest rates.

But the question is, did the situation actually turn out as Powell said? Does it have nothing to do with boosting the job market and saving the economy?

Opposing view: the 50 basis point rate cut is mainly aimed at addressing an economic recession, and "recalibration" is just an excuse.

Philip Marey, a Federal Reserve observer at Rabobank, expressed a different opinion on Powell's "recalibration."

The argument of 're-calibration' and the message of significant interest rate cuts are contradictory. Powell states that the current state of the US economy is good, and this interest rate cut decision is to maintain this state.

Why not simply cut the interest rate by 75 basis points if using a 50 basis point rate cut to convey a strong economy message?

Marey first believed that the 50 basis point rate cut was due to a deteriorating labor market that could lead to a mild economic recession. If the future economy suddenly deteriorates, the Fed may have to take more aggressive action, such as a 75 basis point rate cut. Can they still use 're-calibration' to explain it then?

Although the Fed denies that monetary policy lags behind the economic situation, this is actually the meaning of 're-calibration'. Powell is just using this more moderate wording to cover up the policy misjudgment and is unwilling to admit that they should have cut interest rates by 25 basis points in July.

It is worth noting that 'New Bond King' Jeffrey Gundlach said in August that interest rates should have been cut in July. The US economy doesn't look so good, and the actual condition of the labor market is very poor. Large interest rate cuts will be needed in the next year, possibly by 150 basis points.

But Marey also stated that if indeed, according to Powell's statement, a 50 basis point rate cut is not the future standard pace, then he still expects the Fed to cut rates by 25 basis points at the upcoming FOMC meetings in November, December, and January next year. The situation after January will depend to a greater extent on the economic policies of the next US government.

Marey also joked that Powell's choice to directly cut interest rates by 50 basis points may also be to gain support from his Democratic colleagues in order to achieve re-election. After all, if Trump is re-elected as president, he is likely to be replaced.

Next, will it be 'Prosperous 1995' or 'Embarrassing 2001'? Pay attention to this data.

"Recalibration" is really about pursuing a new neutral interest rate, as Powell said, rather than a new pace of interest rate cuts, or a new rhetoric from the Fed to save the weak economy.

If the facts prove Powell's statement correct, then he may become the "contemporary Greenspan", in comparison to the "prosperous 1995".

Looking back, under the leadership of then-Chairman Greenspan, the Fed initiated an interest rate cut cycle, raising rates from 3% in early 1994 to 6% in February 1995, successfully guiding the economy to a soft landing and causing a surge in U.S. stocks. After the initial rate cut on July 6, 1995, the S&P 500 rose more than 40%.

But if Marey and the "new bond king's" views are ultimately proven correct, what may happen next is the possibility of a "awkward 2001", where the 50 basis point rate cut may just be the first step for the Fed to open the door to easing.

In January 2001, the Fed also started a new round of easing with a 50 basis point rate cut. In the closed-door meeting at the time, Fed Chairman Greenspan stated that the Fed would not signal a sharp drop in the federal funds rate, but rather wanted to convey a more cautious and gradual approach.

However, in order to avoid an economic "hard landing" caused by the bursting of the internet bubble, the Fed had to cut interest rates 10 times that year, directly lowering rates from 6% at the beginning of the year to 1.75% at the end of the year.

So how should we judge? Dario Perkins, the Global Macro Director at TS Lombard, has proposed an indicator.

Perkins believes that a true indication of an economy heading towards a recession is slow rising in unemployment rate and a rapid decrease in the number of new job creations, rather than what the market is currently focused on.

Editor/ping