ROI-Wall Street slump could secure Fed rate cut: McGeever

By Jamie McGeever

ORLANDO, Florida, Nov 24 (Reuters) - If worries over excessive AI optimism persist, turning the recent market wobble into something more seismic, financial stability risks from plunging asset prices could force the Federal Reserve to cut interest rates.

Until a few days ago, financial stability concerns typically supported calls for the Fed to pause its easing cycle, not continue it. Cleveland Fed President Beth Hammack warned on Thursday that further rate cuts "could come at the cost of heightened financial stability risks", a sentiment echoed by Dallas Fed President Lorie Logan the following day. Given how high U.S. stock prices and how tight credit spreads have gotten, it's a reasonable call.

But if the recent wave of equity selling and surge in volatility persists, and financial conditions move in the opposite direction, the calculus may change. To be sure, this is not a base-case scenario. Traditionally, the Fed would not step in to calm markets unless liquidity had evaporated and market functioning was impaired. And while market sentiment and performance have both crumbled, we're nowhere close to crisis territory, especially after Friday's bounce.

But this time around, things may not need to get that bad for the Fed to intervene. That's because, by many economists' calculations and even some policymakers' admissions, the health of the 'real' economy now depends on the wealth of Wall Street more than ever.

WALL STREET IS MAIN STREET

The link between Wall Street performance and Main Street activity has strengthened in recent years.

More than half of all U.S. households hold equities via retirement and mutual funds, but the richest Americans own the bulk of financial assets - the top 1% owns around half of the stock market, and the top 10% owns around 90%. These asset holders are responsible for a huge chunk of U.S. economic activity. Estimates this year from Moody's Analytics chief economist Mark Zandi suggest that as much as half of all U.S. consumer spending comes from the top 10% of earners. There has been some pushback against that figure. University of Berkeley's Antoine Levy says it is closer to 35% of consumer spending.

But, regardless, there's no disputing the fact that the rich drive U.S. consumption, which accounts for up to 70% of the country's economic activity.

You can see why policymakers would be keen to avert a rout on Wall Street. Controlling asset prices is not part of the Fed's mandate, of course, but ensuring financial stability and the general wellbeing of the economy is - and the three considerations are increasingly intermingled.

EYE OF THE STORM

Markets found their footing on Friday, but things were looking much more ominous 24 hours before. Stocks plunged on Thursday despite AI leader Nvidia (NVDA) reporting bumper revenues and an even brighter outlook. Strategists at Citi noted that the S&P 500's peak-to-close return that day was -3.4%, in the top 95 percentile for such moves since 1996. It's also the biggest decline since the 5.5% fall on April 8. But there was a clear catalyst for the market's slump and recovery in April: Trump's 'Liberation Day' tariffs and subsequent roll back. What's more, there was plenty of room for Wall Street's rebound to run, as stocks were around 20% off their highs at the time. That's not the case now. The S&P 500 and Nasdaq were only 5.5% and 9% off their respective October 29 peaks at their lows on Friday. With fund managers looking to lock in profits ahead of year end, selling may have further room to run.

But here's the thing. The catalyst for Friday's bounce appears to have been increased market bets of a Fed rate cut next month following dovish remarks from New York Fed President John Williams.

Chair Jerome Powell has made clear any further easing is contingent on the labor market, and he would have cover - the unemployment rate rose to a four-year high of 4.4% in September. The recent market volatility, which we've likely not seen the end of, may seal the deal.

(The opinions expressed here are those of the author, a columnist for Reuters) Enjoying this column? Check out Reuters Open Interest (ROI), your essential source for global financial commentary. ROI delivers thought-provoking, data-driven analysis of everything from swap rates to soybeans. Markets are moving faster than ever. ROI can help you keep up. Follow ROI on LinkedIn and X.

(By Jamie McGeever; Editing by Chizu Nomiyama )