The magnitude of the Federal Reserve’s much-anticipated interest rate cut this week will have less impact on Wall Street than the health of the U.S. economy, according to top Wall Street strategists.
The Federal Reserve is widely expected to cut interest rates for the first time in four years early Thursday, with investors wavering between whether the central bank will cut by 25 basis points or 50 basis points. Expectations of easing policy and strong economic data so far have pushed the S&P 500 up more than 30% since November, and investors are now assessing whether the United States can avoid a recession after years of high interest rates.
“If the jobs data weakens from here, markets are likely to trade in a risk-off tone regardless of whether the first Fed rate cut is 25 basis points or 50 basis points,” Mike Wilson of Morgan Stanley wrote in a note.
Wilson is one of the most notable bears until mid-2024. On the other hand, he said that if employment conditions improve, then the Federal Reserve will cut interest rates by 25 basis points by mid-2025, which could further support U.S. stock valuations.
Forecasters at Goldman Sachs and JPMorgan Chase also warned that the Fed’s policy rate itself has become less important to U.S. stocks given the uncertainty over the economic outlook.
“While some investors believe the pace of the Fed’s rate cuts will be a key determinant of U.S. stock returns in the coming months, the trajectory of economic growth is ultimately the most important driver of U.S. stocks,” Goldman Sachs strategist David Kostin wrote in a Sept. 13 note.
Over the past two months, U.S. stocks have seen greater volatility due to the uncertain economic outlook. The looming U.S. election has become another risk in the near term.
In addition, signs of a slowing economy will weigh on lofty expectations for profit growth in coming quarters. In the past few weeks, more analysts have cut their profit forecasts than raised them, according to an index from Citigroup.
Historical signals
JPMorgan Chase & Co. strategy team, including Mislav Matejka, looked at the S&P 500's historical reaction to Fed rate cuts for clues.
The strategist said that in the past, the initial reaction of U.S. stocks to policy easing has been mild, and "subsequent performance has varied widely, depending on which growth outcome prevails."
He said that “not surprisingly” rate cuts ahead of the recession had driven the benchmark lower throughout the year, while resilience in economic growth had driven “high returns.” Matejka warned that in contrast, in previous cycles, the gauge had risen only about 4% on average in the 12 months before policy easing began.
Goldman's Kostin said historical analysis may not be reliable in the current situation, given the magnitude of easing already priced into the market. Swap traders are pricing in more than 200 basis points of easing by the Fed by May.
"If the market reflects that the Fed's easing policy has less impact because the economy proves resilient, then U.S. stocks will rise despite higher bond yields," Kostin said. "Conversely, if the market believes that the Fed will ease policy further because of worsening economic data, then U.S. stocks will struggle even if bond yields fall."
Article forwarded from: Jinshi Data
