Traders often know that when it comes to the Federal Reserve, timing is everything—and the impending rate-cut cycle could be one of the most impactful moves for market volatility and sentiment this year. Drawing parallels to the classic line “The First Cut Is the Deepest,” the central bank’s first rate cut in this cycle could deliver the most significant jolt to both market dynamics and investor psychology.
All eyes will be on Federal Reserve Chair Jerome Powell this week, as he addresses policymakers and market watchers from Jackson Hole, Wyoming. His Friday speech may offer clues about the Fed’s approach to monetary policy and signal whether the central bank is considering an interest rate cut in its upcoming September meeting. Investors are intensely focused on the Fed’s next move, hoping for signs that the long stretch of tightening may be near its end.
The Fed’s aggressive rate hikes that began in 2022 aimed to combat runaway inflation, raising rates to their highest level in over two decades. However, with inflation showing signs of slowing, traders are increasingly pricing in the possibility of a shift in the Fed’s stance—something that could rejuvenate both the economy and capital markets.
Market Volatility Amid Speculation
While traders are anticipating relief, the uncertainty surrounding when and how the Fed will make its first rate cut is fueling a wave of volatility. According to Macan Nia, co-chief investment strategist at Manulife Investment Management, the shifting expectations around the Fed’s rate policy have been a major driver of market swings.
“Interest-rate expectations have fluctuated wildly over the past two years,” Nia told MarketWatch. “That constant change has led to heightened market volatility, and we’re likely to see more of that until the Fed makes its move.”
Currently, traders are left to speculate on the timing, size, and frequency of future cuts, all of which keeps uncertainty—and volatility—high. While no definitive plan for rate cuts has been announced, the consensus is that the first cut will be pivotal for market sentiment. Nia believes that this initial move by the Fed could serve as a psychological balm for speculators who have been anxiously awaiting a change in monetary policy.
“That first cut is psychologically critical for the market,” Nia said. “Investors have been on edge waiting for the Fed to shift course, and when the first cut finally comes, it’s like removing a Band-Aid—sudden and sharp, but it brings relief.”
Global Central Banks Provide Context
Other global central banks have already begun cutting rates, offering a glimpse of what could come in the U.S. market. For example, the Bank of Canada became the first G-7 nation to deliver a rate cut, lowering rates by 25 basis points in June and following up with another cut shortly after.
“We’ve seen this play out in Canada,” Nia noted. “Once that first cut happens, the path for further reductions becomes clearer. But until that moment arrives, markets remain uncertain, and uncertainty breeds volatility.”
This theme of uncertainty has certainly played out in the U.S. markets. The Nasdaq Composite ($COMP) has recently fluctuated in and out of correction territory, while the Cboe Volatility Index ($VIX) spiked earlier this month. Traders should prepare for continued volatility in the lead-up to and immediately following the first rate cut.
Navigating Post-Cut Volatility
Despite the expected volatility, Nia encourages investors to stay calm and focus on the long-term potential. While markets are likely to experience a short-term reaction, the first rate cut could set the stage for more stable, sustained growth over the coming years.
“There’s going to be short-term volatility—embrace it,” Nia advised. “Traders need to have the conviction to look beyond these short-term disruptions. Historically, the returns over the three- to five-year periods following a rate cut are often quite positive.”
For traders and investors, the immediate aftermath of the first cut may require some tactical maneuvering. However, with volatility often comes opportunity. For those willing to ride out the short-term waves, the longer-term outlook may be more favorable, especially as markets recalibrate in the post-rate-cut environment.
Key Takeaways for Traders:
- Anticipate Increased Volatility: Expect heightened market swings as speculation over the Fed’s rate cuts continues. The first rate cut is likely to cause a significant spike in volatility, both before and immediately after the announcement.
- Psychological Impact of the First Cut: The initial rate cut is expected to play a major role in calming investors’ nerves and providing clarity, which could reduce uncertainty and improve market sentiment over time.
- Look to Global Markets for Insight: The experiences of other central banks, such as the Bank of Canada, suggest that once the first cut is made, the path for further cuts becomes clearer, potentially leading to more predictable market behavior.
- Prepare for Short-Term Disruptions: In the short term, volatility is unavoidable. Traders should be prepared to endure market turbulence but keep their sights on longer-term gains.
Conclusion
Traders should remain vigilant as the Fed approaches its potential pivot from tightening to easing monetary policy. The first rate cut in this cycle will likely be a watershed moment for the markets, triggering a surge in volatility while also offering the possibility of a more stable economic environment in the future. Those who stay focused on the long-term horizon and manage the emotional rollercoaster of market fluctuations may find themselves well-positioned for the opportunities that follow.
