By Lewis Krauskopf and Davide Barbuscia
NEW YORK (Reuters) – One of the Federal Reserve’s most important meetings in recent memory has investors’ attention squarely focused on one question: Did the central bank start cutting rates 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 — and assured investors that the massive cut was a move to protect a resilient economy, rather than an emergency measure amid recent weakness in the labor market. Bets on the size of the rate cut had been mixed in the days leading up to the meeting and were nearly evenly split by Wednesday morning.
The extent to which Powell’s forecasts pan out will likely be a key factor in stock and bond price performance for the remainder of 2024.
Prospects of a “soft landing,” in which the Fed brings down inflation without plunging the economy into recession, have lifted stock and bond markets this year, though signs of a softening labor market have fueled concerns that the Fed is slow to intervene to support growth.
“Right now, it looks like the market is pausing to digest what was a surprise to many,” said Eric Beyrich, co-CIO of investment advisory firm Sound Income Strategies. “There are still going to be people who are thinking, ‘Wow, if the Fed is cutting this much, what are they seeing that we’re not seeing that suggests the economy is going to get worse?'”
Market reaction on Wednesday was relatively muted, as stocks, Treasuries and the dollar reversed initial rallies after the decision. The S&P 500 closed 0.3% lower, after rising as much as 1% during the session. The index has gained nearly 18% this year and is close to a record high.
In remarks after the decision, Powell called the move a “recalibration” to account for the sharp decline in inflation since last year and said the central bank wanted to stay ahead of a potential weakening in the labor market.
Some investors were skeptical about that sunny outlook.
“Despite what Chairman Powell said at the press conference, a 50 basis point move 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 ahead of the meeting, favoring investment-grade credits over riskier high-yield bonds because of the expected deterioration in the economy.
However, many others were convinced that the rate cuts were a positive development for the market and would boost the economy.
“I think this significantly increases the likelihood that the Fed can stick the landing, which will ultimately be positive for risk assets,” said Jeff Schulze, head of economic and markets strategy at ClearBridge Investments.
Stocks have indeed done well after rate cuts, as long as the economy stays out of recession. The S&P 500 has gained an average of 14% in the six months following the first cut of a rate-cutting cycle, when the Fed cut during a non-recession period, according to Evercore ISI data going back to 1970. That compares with a 4% drop in that period after the first cut when the economy was in recession.
Rick Rieder, chief investment officer for global fixed income at BlackRock, said investors may have overreacted to recent weaker-than-expected labor market reports. Other data, such as estimates of gross domestic product growth, continued to show a resilient economy.
“I think the markets got ahead of themselves again in terms of interpreting that data, which was very soft,” he said. “Chairman Powell said it’s a solid economy, and it is.”
LONG-TERM ADJUSTMENTS
Fed officials have updated their view on interest rates based on their latest projections from June. While they now expect deeper cuts, those rate forecasts were still above market expectations of a more accommodative central bank.
The Fed said it expects the fed funds rate — currently in the range of 4.75% to 5% — to stand at 3.4% by the end of next year, while rate traders were betting on around 2.9%. The Fed’s end point for rate cuts also reflected a slight upgrade, to 2.9% from 2.8%.
The outlook gap may have triggered a reversal in Treasury markets, triggering a selloff in longer-dated Treasuries on Wednesday. The benchmark 10-year Treasury yield, which moves inversely with bond prices, is trading at around 3.73 after hitting its lowest level since mid-2023 earlier this week.
“Given the pace at which the rate cuts have been priced in, I think this is the right response,” said John Madziyire, head of US Treasuries and TIPS at Vanguard, who had been expecting long-term interest rates to rise.
Others looked even further ahead, with some pointing out that the outcome of the US presidential election could make future rate cuts more difficult.
“If trade wars were to erupt under a Trump presidency, that could be negative for fixed income,” said Andrzej Skiba, head of U.S. fixed income for 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)
