Analysis-After the jumbo Fed rate cut, the market is hoping for a soft landing from the US

By Lewis Krauskopf and Davide Barbuscia

NEW YORK (Reuters) – One of the most important Federal Reserve meetings in recent history focused investors on just one question: whether the central bank has started its rate-cutting cycle in time to prevent the economy from slowing too quickly .

The Fed on Wednesday offered a 50 basis point rate cut – lowering borrowing costs for the first time in more than four years – and assured investors that the jumbo-sized cut was a measure to protect a resilient economy, more rather than an emergency response to recent weakness. on the labor market. Bets on the size of the rate cut had taken place in the days leading up to the meeting and were close to an even split on Wednesday morning.

The extent to which Powell’s outlook is likely to be a key factor in the trajectory of stocks and bonds for the rest of 2024.

The prospect of a “soft landing,” in which the Fed cuts inflation without pushing the economy into recession, has boosted stocks and bonds this year, although signs of a softening labor market have fueled concerns that the Fed may be slow to shore up action. increased growth.

“Right now, it looks like the market is going to pause to digest what was for many a surprise,” said Eric Beyrich, co-CIO of investment advisory firm Sound Income Strategies. If the Fed tapers like this, what do they see that we don’t that suggests the economy is going to get worse?

Market reaction on Wednesday was relatively muted as stocks, Treasuries and the dollar returned to their initial highs post-decision. The S&P 500 ended up 0.3%, after rising as much as 1% during the session. The index is up nearly 18% this year and is near an all-time high.

In comments following the decision, Powell called the move a “recalibration” to account for last year’s sharp drop in inflation and said the central bank wanted to stay ahead of any potential labor market weakness.

Some investors were skeptical about this sunny outlook.

“Despite what Chairman Powell says in the news conference, a 50 basis point move indicates 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 at the meeting, favoring investment-grade credit over riskier high-yield bonds ahead of the expected deterioration in the economy.

Many others, however, believed that the rate cut was a positive development for the market and would stimulate the economy.

“I think this dramatically increases the chances that the Fed will be able to hold the landing, which will ultimately be bullish for risk assets,” said Jeff Schulze, head of economic and market strategy at ClearBridge Investments.

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Indeed, stocks have performed well in the wake of rate cuts — as long as the economy has stayed out of recession. The S&P 500 has averaged a 14% gain in the six months following the first cut in a rate-cutting cycle when the Fed cut in a non-recessionary period, data from Evercore ISI dating back to 1970 shows. That compares with a 4% drop in that period after the initial cut, when the economy is in a recession.

Rick Rieder, chief investment officer for global fixed income at BlackRock, said investors may have overreacted to recent labor market reports, which came in weaker than expected. Other data, such as estimates of gross domestic product growth, continued to point to a resilient economy.

“I think the markets got ahead of themselves again in terms of the interpretation of this data was very poor,” he said. “Chairman Powell said it’s a solid economy, and it is.”

LONG TERM ADJUSTMENTS

Fed officials updated their views on interest rates from their last forecast in June, but while they now anticipate deeper cuts, those rate forecasts remained 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 3.4% by the end of next year, while rate traders are betting on around 2.9%. The Fed’s endpoint for rate cuts also reflected a slight increase to 2.9% from 2.8%.

The outlook gap may have triggered a reversal in Treasury markets, triggering a sell-off in longer-term Treasuries on Wednesday. The benchmark 10-year Treasury yield, which moves inversely to bond prices, is at about 3.73 after hitting its lowest level since mid-2023 earlier this week.

“In terms of the pace at which the cuts have been priced, I think that’s a fair reaction,” said John Madziyire, head of U.S. Treasuries and TIPS at Vanguard, which was betting on long-term yields rising.

Others looked even further ahead, with some pointing out that the outcome of the US presidential election could complicate the path to rate cuts going forward.

“If trade wars were to follow 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. “It 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)