What impact might Fed policy easing have on the US stock market?

Federal Reserve Chairman Jerome Powell late last week gave the clearest indication yet that the U.S. central bank is about to do what markets have long expected - cut interest rates, which are currently at their highest high level of the last two decades.

In his speech at the annual economic symposium in Jackson Hole, Powell pointed out that the time has come for the monetary policy rate to adjust, given that inflation has fallen significantly from the pandemic record in mid-2022, and the labor market, although still relatively stable, is showing signs of weakness.

"The direction is clear, but the timing and pace of rate cuts will depend on the data that will emerge, the outlook and the balance of risks," said the Fed president.

Traders are betting on a key rate cut by the Federal Reserve next month, currently in the range of 5.25% - 5.5%, with a 38% chance the bank will cut as much as 50 basis points (0 .5%), according to data posted yesterday by the CME FedWatch Tool.

The question is what impact the easing of monetary policy may have on the US stock market, which this year has marked a succession of new all-time highs.

• Winnie Sun, Sun Group Wealth Partners: "Investors should not be quick to make massive portfolio changes following Powell's speech"

Marguerita Cheng, chief executive of wealth manager Blue Ocean Global Wealth, says generally lower interest rates are positive for stocks. "Companies may feel more comfortable expanding if borrowing costs are lower," Cheng said, according to CNBC.

But uncertainty about the number of future rate cuts, as well as their size and pace, means investors should not be quick to make massive portfolio changes following Powell's speech, said Winnie Sun, managing director of Sun Group Wealth Partners. . "Things can change," she added.

• Craig Fehr: "Much of the benefits of lower rates have already been baked into stock prices"

Craig Fehr, CFA, analyst at Edward Jones Investments, says that if until now the Fed's approach has been mainly aimed at reducing inflation, from now on the decisions of the central bank of the United States will focus more on supporting the labor market and the economy, which gives some signs of fatigue.

"We expect this rate cut cycle to start and continue gradually. Barring a sudden and surprising change in the path of inflation or unemployment, we think the Fed will cut the policy rate by 25 basis points (n.a. in September)," Fehr wrote in his latest weekly analysis, adding that, in the view of Edward Jones Investments, a string of interest rate cuts of a quarter of a percentage point is the most likely scenario.

On the other hand, Powell emphasized that the Fed will calibrate its policy based on economic data, which the analyst interpreted to mean that the bank may not cut rates in a consistent manner this year and next.

"We believe that the transition to a phase of monetary policy relaxation will be beneficial for the financial markets next year. It's just that this was widely anticipated, so much of the benefit of lower rates has already been baked into the stock and bond markets. Short-term and long-term Treasury yields have fallen sharply this year, reflecting expectations of lower interest rates from the Fed. The stock market is also up nearly 40% since last October," the analyst wrote.

• "The Fed's change is good for stocks, but it probably won't eliminate periodic swings or market volatility for the rest of 2024," CFA analyst believes

Craig Fehr says that in Edward Jones Investments' view, the benefits of lower interest rates have not been fully exhausted for the equity market.

"The Fed's ability to cut rates in a way that supports a soft landing of the economy (avoiding recession) should, in our view, provide room for corporate earnings to grow at a healthy pace next year, which we believe that it will provide the necessary fuel for this "bull" market to continue this year and into 2025," the analyst pointed out.

However, the easing of monetary policy does not necessarily mean that a smooth rise in the stock market will follow in the short term, Fehr points out. "We don't think that the reactions (n.r. of the market) stemming from fears about economic growth are over. In addition, the US presidential election and geopolitical uncertainties are likely to bring more episodes of anxiety in the coming months. We think this change by the Fed is broadly beneficial for equities, but likely won't eliminate periodic swings or market volatility for the rest of 2024," says Fehr.

According to the analyst, the interest rate cut is not a panacea for the markets and the economy, but it is a step towards less burdensome borrowing costs for consumers and companies. Lower rates can also support stock valuations, as history shows.

"The repercussions of the dot-com bust and the events of September 11, 2001, as well as those of the global financial crisis, extended well beyond the beginning of rate-cutting cycles. But we think history is on the side of investors in terms of stock market returns after the rate cut," Fehr wrote.

As the table shows, during periods such as 1987, 1995, and 1998, when the first rate cut was not followed by an economic recession, US stock market returns over the next one to two years were particularly strong.

"A recession cannot be ruled out completely, but we believe that the economic expansion will continue. In our view, the start of interest rate cuts by the Fed in the current conditions of employment, consumer spending and GDP growth supports such a scenario and a generally positive outlook for financial markets," the CFA analyst concluded.

• Mohamed El-Erian: "Increasing market volatility seems more likely after Jackson Hole"

Renowned economist Mohamed El-Erian believes that with the speech at the end of last week, Powell wants to reinforce the idea that the Fed is abandoning the approach aimed only at winning the battle with inflation, moving towards a dual approach, namely price stability and maximum employment workforce. But the market doesn't think so, writes El-Erian in an editorial published in the Financial Times.

"The immediate market reaction was to rally further on the idea that the Fed would cut interest rates by around 100 basis points over the next four months, with an increased likelihood of a 50 basis point cut in September to follow. of another 100 basis points over the next six months. "Traders are doubling down on a single Fed mandate that will focus on employment, with the bank eager to implement "insurance cuts' to significantly reduce the likelihood of a recession," says El-Erian.

According to the economist, the markets have already been operating for some time with the idea of a change in monetary policy, which involves considerable cuts in interest rates in the next twelve months. "Ironically, Powell's speech encouraged them to have even more confidence. It's just that the markets are, at least for now, shrugging off his import remarks that "the limits of our (not the Fed's) knowledge ... require humility and a questioning spirit focused on learning the lessons of the past and applying them flexibly to the challenges current". In conclusion, they (n.r. investors) risk additional market and narrative volatility (n.r. in the sense of changing Powell's speech) in the coming months," the economist pointed out.

• Garry Evans: "The Fed will probably cut interest rates in September, but that won't prevent the looming recession"

There are also voices that the decrease in the cost of borrowing in US dollars cannot prevent the looming economic recession in the United States.

"The idea that we will have a smooth landing is very well rooted in the market. We don't believe that, and we see signs that the economy is going down," Garry Evans, chief asset allocation strategist at BCA Research, told CNBC, as reported by Business Insider.

In his opinion, the labor market is the main source of concern, given that revised data from the United States Bureau of Labor Statistics showed that the number of new jobs created in March was 818,000 lower than initially reported.

"These data, plus the rising unemployment rate, are a cause for concern," said the strategist. According to Business Insider, the unemployment rate in the United States rose from 3.4% in April 2023 to 4.3% last month, the highest level since October 2021.

"There are some things that fall apart pretty quickly," Evans added, including recent production data. Manufacturing activity in the United States fell to the lowest level since November last year, according to data published earlier this month by the Institute for Supply Management, the American publication also writes.

According to strategist BCA Research, labor and manufacturing data, along with a host of global data such as Japan's weak exports, point to a difficult global economic outlook.

"They're telling us that the global economy doesn't have a very solid foundation," Evans said, adding that the Fed is likely to cut interest rates in September, but that won't prevent the looming recession, writes Business Insider.

From the beginning of the year to the end of last week, the Dow Jones index was up 9.2%, while the Nasdaq Composite, of companies active in knowledge-intensive fields, was up 19.1%. The S&P 500 index was up 18.1%, just shy of the last all-time high set in the middle of last month.