Morgan Stanley just made a big call after a surprise statement from the Fed. Here's what it says investors should be doing in response.
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- Morgan Stanley says the market is underestimating the probability of a larger-than-expected interest rate cut at the July FOMC meeting, attributing their call to a key phrase.
- The firm also reveals the trades they've hand-picked to profit from the FOMC's imminent maneuver.
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After a few tumultuous months filled with angst and worry, the Federal Reserve's June policy announcement provided investors with the soothing relief they were so desperately seeking.
Market participants leaned in with a sanguine ear to hear the Fed's proclamation - and in a lullaby-esque, pacifying manner the FOMC delivered.
"The projections of appropriate policy show that many participants believe that some cut in the federal funds rate will be appropriate in the scenario that they see as most likely," the official statement read.
That's exactly what investors wanted to hear. Cuts are officially on the table.
The probability of a rate cut in July - as implied by future rate contracts - now stands firmly at 100%, with a 76% chance of a 25-basis-point cut, and a 24% chance of a 50-point move.
However, one Wall Street behemoth thinks the market is being too conservative.
In a recent note to investors, Morgan Stanley called for a 50-bp cut in just six weeks, which equates to a cut double the size of market expectations in roughly half the time. And the firm attributes their zealousness to a key statement in the press conference following the initial announcement.
"An ounce of prevention is worth a pound of cure," said Jerome Powell, Federal Reserve Chair, when asked about a choice between a 25-bp and a 50-bp cut.
This salient utterance leads Morgan Stanley to believe that the FOMC's preferred policy adjustment path will require a faster, more aggressive approach. Shoot first, ask questions later, if you will.
The firm added: "When policy is close to zero bound it's better to act more quickly and more aggressively up front."
If the Federal Reserve lops 50bp off their benchmark interest rate in July, stronger economic growth and heightened inflation should ensue, leading Morgan Stanley to believe that investors should bet on the yield curve steepening and US bonds outperforming.
The firm's trade amounts to this: buy short-term Treasurys, and sell long-term Treasurys and European bonds.
Their specific trade suggestions are outlined below:
- Enter US Treasury 2s10s steepener at 28bp
- Maintain US Treasury 2s30s steepener at 79bp
- Maintain long Treasurys and Canadian government bonds vs. short European bunds and UK gilts
- Enter 5s30s real-yield steepener at 53bp
A plethora of economic data is due out between now and the July meeting, making it inherently difficult to predict the future path of monetary policy within US borders. Couple this notion with the impending Trump-Xi meeting at the G-20, and suddenly the ensuing environment becomes increasingly abstruse.
A lot can change in six weeks. Position accordingly.