By Lewis Krauskopf and Davide Barbuscia
NEW YORK (Reuters) – One of the Federal Reserve’s most important meetings in recent history has focused investors’ attention squarely on one question: whether the central bank has started its rate-cutting cycle in time to prevent the economy from slowing too quickly.
The Fed delivered a 50 basis point rate cut on Wednesday, lowering borrowing costs for the first time in more than four years, assuring investors that the sweeping cut was a measure to secure a resilient economy, not one emergency response to the recent weakness. on the labor market. Bets on the size of the rate cut fluctuated in the days before the meeting and were almost evenly split on Wednesday morning.
The extent to which Powell’s outlook comes to fruition will likely be a key factor in the trajectory of stocks and bonds for the remainder of 2024.
Prospects of a “soft landing,” where the Fed cuts inflation without pushing the economy into recession, have lifted stocks and bonds this year, although signs of a weakening labor market have fueled concerns that the Fed may be too late with inflation taking action. grow up.
“Right now, it appears the market is going to pause to process what came as a surprise to many,” said Eric Beyrich, co-CIO of investment advisory firm Sound Income Strategies. “There will still be people who think, ‘Wow, if the Fed is making big cuts like this, what are they seeing that we’re not seeing that indicates the economy is getting worse?’”
Market reaction was relatively muted on Wednesday as stocks, government bonds and the dollar followed initial rallies after the decision. The S&P 500 ended 0.3% lower after rising as much as 1% during the session. The index is up almost 18% this year and is near a record high.
In comments after the decision, Powell called the move a “recalibration” to take into account the sharp decline in inflation since last year, and said the central bank wanted to stay ahead of any potential weakening in the labor market.
Some investors were skeptical about that bright prospect.
“Despite what Chairman Powell says at the press conference, a move of 50 basis points does indicate that there is concern that they are behind the curve,” said Josh Emanuel, chief investment officer at Wilshire.
Emanuel said he was already overweight bonds when he entered the meeting, favoring investment-grade credits over riskier high-yield bonds ahead of an expected deterioration in the economy.
However, many others believed that the interest rate cuts were a positive development for the market and would stimulate the economy.
“I think this dramatically increases the chances that the Fed can stick the landing, which will ultimately be bullish for risk assets,” said Jeff Schulze, head of economic and market strategy at ClearBridge Investments.
Stocks have done well after interest rate cuts as long as the economy stayed out of recession. The S&P 500 has averaged a gain of 14% in the six months following the first cut of a rate-cutting cycle, when the Fed cut in a non-recessionary period, according to Evercore ISI data dating back to 1970. That compares with a drop of 4% in that period after the first austerity, when the economy was in recession.
Rick Rieder, chief investment officer for global fixed income at BlackRock, said investors may have overreacted to recent labor market reports that were weaker than expected. Other data, such as gross domestic product growth estimates, continued to point to a resilient economy.
“I think the markets have again gotten ahead of themselves in terms of interpreting the data which has been very weak,” he said. “Chairman Powell said it’s a solid economy, and it is.”
LONG TERM ADJUSTMENTS
Fed officials updated their view on interest rates from their latest projections in June, but while they now anticipate deeper cuts, these rate forecasts remained above market expectations of a more dovish central bank.
The Fed said it expects the fed funds rate – currently between 4.75% and 5% – to reach 3.4% by the end of next year, while interest rate traders expect around 2.9%. The Fed’s endpoint for rate cuts also reflected a slight increase, from 2.8% to 2.9%.
The difference in outlook may have sparked a reversal in government bond markets, prompting a sell-off in longer-dated government bonds on Wednesday. Ten-year Treasury yields, which move inversely to bond prices, are at around 3.73, after hitting their lowest level since mid-2023 earlier this week.
“In terms of the pace at which the cuts were priced in, I think this is an appropriate response,” said John Madziyire, head of US Treasuries and TIPS at Vanguard, who bet on a rise in long-term rates.
Others looked even further ahead, with some pointing out that the outcome of the US presidential election could complicate the path for future rate cuts.
“If trade wars were to break out under the Trump presidency, it could be negative for fixed income,” said Andrzej Skiba, head of U.S. fixed income at RBC Global Asset Management. “That would be inflationary and limit the Fed’s ability to cut rates.”
(Reporting by Lewis Krauskopf and Davide Barbuscia; additional reporting by Suzanne McGee; Editing by Ira Iosebashvili and Muralikumar Anantharaman)