Do Rate Cuts Really Make an Impact?

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Includes: DIA, QQQ, SPY
by: Chad Brand

I find it very interesting that Wall Street has soared the last two days on hopes of more Fed rate cuts. On one hand, this makes sense, but on another, it baffles me.

First of all, stocks do better historically when rates are falling. It's a mathematical relationship; lower interest rates increase the present value of future cash flows and vice versa. Lower rates also make stocks more attractive relative to other income-related asset classes. That's the general concept propelling stocks higher this week, but what about the specific situation we face today?

The current dislocation in the credit markets has really hurt the market lately. We all know the state of the housing, mortgage, and mortgage-backed securities markets, but a general lack of liquidity in many other areas of credit are really having a negative impact on the ability of many companies to conduct normal business lines that require liquidity to fund operations.Will more Fed rate cuts help this part of the problem? The market's move in the last two days signals that it will, but I am skeptical.

My thought process isn't very complex. The liquidity crisis has gotten meaningfully worse since the Fed started cutting rates (there have been 75 basis points of cuts so far). To me, that indicates that another rate cut on December 11th (even 50 more basis points) won't have as much of a positive impact on the credit markets as recent stock market action would have you believe. What do you think?