Trading Day: Fed hopes melt, stocks sink

By Jamie McGeever

ORLANDO, Florida (Reuters) -Wall Street tumbled and Treasury yields rose on Thursday as expectations of a Federal Reserve interest rate cut next month faded rapidly, while the dollar also fell in a bleak session for U.S. asset prices.

More on that below. In my column today I look at the emerging parallels between the U.S. and Japan, and how both countries are deploying a rather unorthodox policy tool in the broader fight to mitigate sticky inflation - fiscal stimulus.

If you have more time to read, here are a few articles I recommend to help you make sense of what happened in markets today.

1. Odds of Fed rate cut in December on knife's edge ashawks, doves face off 2. US government opens back up but deep political divisionsremain 3. European officials consider pooling dollars to lessenFed reliance after Trump shocks 4. How the yen tripped up investors...again 5. Markets face down 2025's upheavals with puzzling ease:Mike Dolan

Today's Key Market Moves

* STOCKS: A sea of red across US, the Americas and Europe.Asia rises, but likely to reverse Friday. Big three US indicespost biggest falls in a month. * SHARES/SECTORS: US consumer discretionaries -2.7%, tech-2.4%. Only energy rises. AI/tech bellwethers - Nasdaq, Mag 7ETF, Philadelphia semiconductor index, Nvidia - all set forbiggest 2-week fall since April. * FX: Dollar index -0.4%, its sixth decline in sevensessions. Colombian peso hits 5-year high before ending down 1%,bitcoin down 4% below $100,000 to lowest since May. * BONDS: US yields up 5-6 bps at the long end of thecurve, extending rise after a weak 30-year auction. * COMMODITIES/METALS: Oil recoups some of yesterday'ssteep losses, up around 0.5%. Gold -1%, silver -2%.

Today's Talking Points

* December Fed cut now only 50-50

A Fed rate cut in December, which was a 90% certainty only a couple of weeks ago according to rates futures markets, is now a coin flip. The rapid shift in market expectations is such that the next fully priced rate cut isn't until March.

Very broadly speaking, a split appears to be forming between Fed governors and regional bank presidents: governors, nominated by the president, are leaning dovish; regional bank presidents, less so. Since 1990, the most dissents at a Fed policy meeting has been four. Fed Chair Jerome Powell will earn his leadership spurs next month.

* Short goodbye from the Big Short

Michael Burry, the 'Big Short' investor who made his fame and fortune betting against the U.S. housing market in the mid-2000s, is closing his hedge fund. On Wednesday, he posted on X that he has bet $9.2 million shorting Palantir stock, although it's unclear if that position is still open.

There's an interesting debate around long-term 'shorts.' Market dynamics, structure, and liquidity are very different from 20 years ago. The 'buy the dip' mentality, built on an expected Fed backstop, is such that investors need bags of nerves, patience and deep pockets like never before.

* The limits of long bond demand

Appetite for U.S. Treasuries this year has been remarkably strong. Just look at where yields are today compared with where they were on January 1 - even the yield on the much-maligned 30-year bond is lower year-to-date.

But auctions of 10- and 30-year debt this week have been met with pretty weak demand. Perhaps yields have fallen too far, and investors are now requiring more compensation for holding longer-dated debt given how sticky inflation is looking.

US, Japan share unorthodox anti-inflation tool – fiscal stimulus

The United States and Japan are both employing a novel inflation-fighting tool: fiscal stimulus. 

U.S. President Donald Trump and Japan's Prime Minister Sanae Takaichi are looking to placate angry electorates squeezed by cost-of-living issues. But offering lavish fiscal giveaways to cool inflation is a bit like trying to bring a raging fire under control by dousing it with gasoline.

Earlier this month, Trump's Republican Party suffered key gubernatorial and mayoral election defeats, where concerns about the high cost of living played a major role.

The White House appears to have heard the electorate loud and clear. The president now seems set on sending a $2,000 check to most U.S. households, a 'tariff dividend' funded via money raised by the cranked-up duties on U.S. imports.

"It's in discussion," Treasury Secretary Scott Bessent said on Wednesday. 

But wait, weren't the hundreds of billions of dollars of tariff revenues meant to help cut the budget deficit? 

Evidently, that's no longer the priority, something that became clear earlier this year when Trump pushed through his 'One Big Beautiful Bill Act'. The package is jammed full of tax cuts that are expected to add $2.4 trillion to the federal budget deficit over the next decade, according to the non-partisan Congressional Budget Office.

The Trump administration's key priority is clearly growth, meaning it will run the economy hot, even if the price for that is above-target inflation. While White House officials have never said this publicly, they appear to accept that having inflation closer to 3% than the Fed's 2% target may be worth it to prop up nominal growth. 

FISCAL HOUSE DISORDER

It looks like Japan's new prime minister is taking a similar approach. 

Rising living costs in Japan were a key factor behind the ruling Liberal Democratic Party's historic election defeat in the summer that led to Takaichi's surprise sweep to power last month.

But instead of seeking to tighten policy to stamp out inflation, Takaichi, like Trump, is advocating loosening the fiscal taps. 

Her newly formed government is preparing an economic stimulus package that will likely exceed last year's $92 billion package. One of its three main aims is to mitigate the impact of rising prices.

She is also filling key government economic panels with advocates of expansionary fiscal policy, and this week indicated that she is willing to water down long-term commitments to getting the country's fiscal house in order. 

Meanwhile, both Takaichi and Trump have made it clear to their respective central banks that they would like to keep monetary policy on the stimulative side too – something many rate-setters might disagree with.

In other words, both leaders appear to be intent on countering the effects of inflation with actions that could very well make inflation worse.

INFLATION DOOM LOOP

Of course, fiscal stimulus can be a powerful and useful tool, especially when directed towards lower-income consumers who will almost always spend the cash they get. 

Both the 2007-09 Global Financial Crisis and the pandemic in 2020 showed that fiscal largesse is essential during times of crisis when the economy is in a liquidity trap, demand has collapsed, and deflation is the dragon to be slain. 

But neither the U.S. nor Japan is facing anything approaching economic catastrophe. At an aggregate level, growth in both countries is on the soft side but steady, unemployment is historically low, and inflation is a full percentage point or more above target. 

It is also unclear how much this fiscal splurge will boost growth. There is no universally agreed measure of the 'fiscal multiplier', how much economic growth is increased by additional government spending or tax cuts. 

But economists do agree that it is higher in recessions than in expansions, when debt-to-GDP ratios are on the small side, and when monetary policy is less "activist," as a San Francisco Fed paper from 2020 put it. In short, this describes an environment completely different from the ones present in both countries today.

Populist fiscal splurges may be politically appealing to Washington and Tokyo right now, but in the context of bringing down inflation it is an unorthodox approach that could make that struggle harder.    

What could move markets tomorrow?

* China industrial production, investment, retail sales,unemployment (October) * Japan earnings - Mizuho, Mitsubishi UFJ, Sumitomo Mitsui * India wholesale inflation (October) * European Central Bank executive board member Philip Lanespeaks * Euro zone trade (September) * Euro zone GDP (Q3, flash estimate) * U.S. Federal Reserve officials scheduled to speak includeKansas City Fed's Jeffrey Schmid, Dallas Fed's Lorie Logan, andAtlanta Fed's Raphael Bostic

Want to receive Trading Day in your inbox every weekday morning? Sign up for my newsletter here. 

Opinions expressed are those of the author. They do not reflect the views of Reuters News, which, under the Trust Principles, is committed to integrity, independence, and freedom from bias.

(By Jamie McGeever;)