Citadel macro expert: When the Federal Reserve cuts rates with such abundant liquidity, “increased risk appetite” is the market’s only conclusion.

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In the context of already-loose financial conditions in the United States, the Federal Reserve still chose to cut rates, sending a positive signal to the market.

Citadel Securities macro strategist Nohshad Shah recently wrote that the Fed’s dovish shift has "flashed a green light" for risk assets for the remainder of this year, and in investors’ eyes, "increasing risk appetite" is currently the only conclusion.

Last week, the Fed initiated its so-called “pre-emptive rate cut,” lowering rates by 25 basis points and confirming a dovish policy stance for the rest of the year. According to the latest Summary of Economic Projections (SEP), policymakers’ median forecast for 2025 calls for three rate cuts, up from two in June, which means the market should view another 25 basis point cut in both October and December as the base case.

In his post-meeting statement and press conference, Powell confirmed that "downside risks to employment have increased." In response, Nohshad Shah pointed out that Powell’s focus has clearly shifted to labor market weakness, driving a change in the stance of core committee members.

According to the article, the direct effect of these actions and comments is that already-loose financial conditions after the April tariff shock will become "even looser," and with strong macroeconomic fundamentals, additional monetary easing is now creating a robust tailwind for risk assets.

Powell’s Focus Shift: Prioritizing Employment and Tolerating Higher Inflation

Shah’s analysis believes that Powell’s latest remarks confirm the Fed’s tolerance for a certain degree of inflation—“3% is the new 2%”—which is increasingly becoming the new normal for central bankers globally.

Within the Fed’s dual mandate, employment has clearly become the favored priority. The Fed’s strategy appears to be “front-loading” this year’s insurance cuts to shield the labor market and prevent economic slowdown.

The Summary of Economic Projections shows policymakers expect only one additional cut by 2026, while revising upward their inflation and growth forecasts for that year. This suggests the Fed hopes to use this year’s cuts to stabilize the labor market, paving a smoother path for policy and inflation to return to target (not expected before 2028).

Shah believes that if the current concern is the labor market, then cutting rates now to guard against weakness is logical.

Strong Economic Outlook, Easing Policies Inject New Momentum

Shah emphasized that the market should not overlook the strong outlook for U.S. economic growth, expressing skepticism about the chances of a near-term recession.

He highlighted a series of data and trends that support his optimism: robust corporate earnings (expected 7.7% year-over-year growth in Q3), healthy household balance sheets, steady consumption (retail sales control group rose 0.7% this week), and accelerating commercial loan growth.

In addition, the U.S. economy is benefiting from a once-in-a-generation boom in AI capital expenditures (already at $400 billion and rising), and government policies aimed at boosting the supply side of the economy (such as deregulation, energy infrastructure, and tax cuts).

Shah believes that on top of such strong economic fundamentals, the combined effect of monetary and fiscal easing is an “exciting combination.”

"Risk Appetite" Is the Only Conclusion

In Shah’s view, when financial conditions are this loose, the only conclusion is "risk-on." This is a clear signal for risk assets to outperform.

For the stock market, as the outlook for future growth becomes more optimistic, cyclical stocks should continue to outperform defensives. In addition, the Fed insisting on rate cuts despite inflation also supports rate-sensitive sectors, especially small-cap stocks and unprofitable tech stocks.

Shah pointed out that the IWM index (Russell 2000 ETF), representing small caps, still has catching up to do compared to the SPY (S&P 500 ETF).

Despite the optimistic outlook, Shah also listed some potential factors that could disrupt the rise of risk assets. First is a severe recession caused by a collapse in economic activity and the labor market, but he believes current data (such as the Dallas Fed WEI index and initial jobless claims) does not support this view.

Second is overvaluation, but S&P 500 earnings per share have largely kept pace with the index. Next is accelerating inflation, which could become a concern in the future but is not a main issue right now. Finally, there is the risk of a spike in long-term bond yields, but that would require a trigger that does not yet exist.

Risk Warning and DisclaimerThe market carries risks; investments should be made cautiously. This article does not constitute personal investment advice, nor does it take into account the special investment objectives, financial status, or needs of any individual user. Users should consider whether any opinions, views, or conclusions in this article fit their specific circumstances. Invest at your own risk. ```