NEW YORK, Sept 19 (Askume) – One of the most important Federal Reserve meetings in recent history focused investors’ attention on one question: whether the central bank would cut interest rates in time to prevent the economy from slowing too fast.
The Federal Reserve cut interest rates by 50 basis points on Wednesday , lowering borrowing costs for the first time in more than four years, and assured investors that the sharp cut was a flexible response to recent labor market weakness, not an emergency reaction. Bets were placed on the extent of the rate cut in the days before the meeting , and bets were about evenly split on Wednesday morning.
The extent to which Powell’s outlook comes to fruition could be a key factor in how stocks and bonds fare through the remainder of 2024.
While signs of weakness in the labor market have raised concerns that the Fed may be able to boost economic growth
“Right now, it looks like the market is going to take a pause in pricing in something that’s going to surprise a lot of people,” said Eric Beirich, co-chief information officer at investment advisory firm Sound Income Strategies. “‘Wow, if the Fed does this big rate cut, what signs do they see that we don’t think the economy is going to get worse?'”
Market reaction was relatively muted on Wednesday, with stocks, Treasuries and the dollar giving up early gains after the decision. The S&P 500 index (.SPX) closed down 0.3% after rising as much as 1% during the session .The index has gained about 18% this year and is close to an all-time high.
In a speech after the decision, Powell described the move as a “rebalancing” in light of the sharp drop in inflation since last year and said the central bank wanted to avoid any potential weakness in the job market.
Some investors are skeptical about this positive outlook.
“Regardless of what Chairman Powell said in the press conference, a 50 basis point increase signals concern that they are behind the curve,” said Josh Emanuel, chief investment officer at Wilshire.
Emanuel said he was more optimistic about bonds coming into the meeting, preferring investment-grade debt rather than riskier high-yield bonds ahead of an expected economic slowdown.
However, many others believe that the rate cut is a positive development for the markets and will boost the economy.
“I think this makes it significantly more likely that the Fed will be successful in taking action that is ultimately beneficial to risk assets,” said Jeff Schultz, head of economics and market strategy at ClearBridge Investments.
In fact, stocks tend to perform well after interest rate cuts, as long as the economy doesn’t go into recession . Evercore ISI data going back to 1970 shows that after the Fed cuts interest rates in a non-recessionary period, the S&P 500 rose an average of 14% in the six months following the first rate cut in a rate-cutting cycle. This is compared to a 4% decline during a recession.
Rick Rieder, chief investment officer for global fixed income at BlackRock, said investors are overreacting to the latest labor market report, which is weaker than expected. Other data, such as GDP growth expectations, show that the economy is resilient.
“I think the market is again reading into the fact that the data is very weak,” he said. “Chairman Powell said it’s a solid economy, and it is.”
Long-Term Adjustments
Fed officials have updated their latest forecasts for June interest rates , but although they now expect more rate cuts, those rate forecasts are still higher than market expectations for a more easygoing central bank.
The Fed said it expects the federal funds rate, currently at 4.75% to 5%, to reach 3.4% by the end of next year, while interest rate traders are betting on about 2.9%. In addition, the Fed’s interest rate cut target improved slightly, to 2.9% from 2.8%.
The outlook gap added to the reversal in the Treasury market, triggering a sell-off in longer-dated Treasuries on Wednesday. The benchmark 10-year Treasury yield, which works against bond prices, is currently around 3.73 after hitting its lowest level since mid-2023 earlier this week.
“Given the pace of the cuts, I think this is the right response,” said John Madzior, head of U.S. Treasuries and inflation-protected securities at Vanguard Group, who is betting on longer-term yields rising.
Others have gone further, with some saying the outcome of the US presidential election could complicate the path to future rate cuts.
“If the trade war continues until Trump leaves office, it could have a negative impact on fixed income,” said Andrzej Skiba, head of U.S. fixed income at RBC Global Asset Management.
