HomeBusinessThe market is rejecting what the Fed says about interest rates

The market is rejecting what the Fed says about interest rates

(Bloomberg) — The Wall Street axiom warns to “never fight the Fed.” But that’s exactly what traders are doing, and it could spark a rally in some of the forgotten corners of the stock market.

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The Federal Reserve’s predictions and comments from central bankers could not be clearer. Investors are being warned that rates will remain higher for longer than they expected, with Fed officials’ average projection calling for one rate cut this year.

And yet cash is flowing into stocks that benefit from lower financing costs. The tech sector saw inflows of $2.1 billion this week, the highest since March, according to data compiled by EPFR Global and Bank of America.

“The market simply isn’t sold on the prospect of inflation and labor market numbers that don’t give the Fed room for multiple cuts this year,” said Keith Buchanan, senior portfolio manager at GLOBALT Investments. “That stubbornness keeps the environment intact that benefits risky assets.”

The central bank’s forecasts for fewer rate cuts this year and Fed Chairman Jerome Powell’s apparently hawkish comments at his press conference on Wednesday didn’t stop the S&P 500 Index from rising above 5,400 for the first time ever, which also happened on Wednesday and held out at least on Friday. The benchmark has risen more than 50% since bottoming in October 2022, during a bear market triggered by the Fed’s drastic rate hikes that began in March 2022 and were aimed at curbing runaway inflation.

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The question for investors now is: what will the market do if the Fed ultimately decides to cut spending?

Historically, rate cuts have been a major turning point that has led to strong stock returns – but only for cycles that aren’t caused by a recession like this one. That would explain why the latest flows data from Bank of America and EPFR Global show a rotation towards the financial, materials and utilities sectors – three crucial groups closely linked to the economy and which have historically benefited from rate cuts as long as they last. of robust economic growth.

The consensus expectation is that economic growth will remain robust, with the Atlanta Fed’s GDPNow model forecasting real GDP growth to rise to 3.1% annualized in the second quarter, up from 1.3% in the first quarter .

“There are few signs on the horizon that there will be a real bumpy landing,” said Carol Schleif, chief investment officer at BMO Family Office.

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Technical boost

Fund managers are also increasing exposure to technology stocks. The Nasdaq 100 Index is up 17% in 2024. Shares of the seven largest companies in the S&P 500 are priced at an average of 36 times expected earnings, compared with a multiple of 22 for the benchmark, according to data compiled by Bloomberg.

Overall stock positioning has now risen to the highest level since November 2021, when the Nasdaq 100 was at a high, according to data for the week ended June 14 compiled by Deutsche Bank AG.

Rules-based and discretionary investors – who rely on predefined guidelines and algorithms to make decisions – drove the jump this week, with positioning in technology rising sharply along with interest rate-sensitive groups such as utilities, staples and real estate.

Should the Fed take a firm dovish stance, defensive corners of the market that pay stable dividends, such as consumer staples and real estate, will also become more attractive, said Terry Sandven, chief equity strategist at US Bank Wealth Management.

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June typically marks a quiet period for markets with lower trading volume heading into summer. But next week has a wildcard: ‘triple witching’. Contracts linked to stocks and indexes expire on Friday, coinciding with the quarterly rebalancing of the indexes, a coincidence that tends to create a burst of volatility and high trading volumes. That could disrupt the positioning in the very short term.

“Next week could be quite eventful for stocks,” said Frank Monkam, senior portfolio manager at Antimo.

–With help from Matthew Griffin.

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