Aggressive Fed tapering could spark another stock market bubble, warns UBS By Investing.com

Investing.com — Aggressive interest rate cuts by the Federal Reserve could set the stage for another stock market bubble, analysts at UBS said in a note.

In their recent note, UBS explains that historically markets have reacted positively in the short term after the first rate cut, gaining an average of 4% over eight months.

“If there was a recession, the markets went down 10%; if there wasn’t, they rose 20% – (with recessions occurring on average 5 months after the rate cut began, a recession occurring 55% of the time during the period),” UBS said

UBS is concerned that a more aggressive Federal Reserve could lead to lower-than-expected rates, potentially triggering a bubble.

They point out that the market expects a minimum Fed Funds rate of 2.8%, while rates have historically fallen below neutral levels during recessions.

UBS argues that a weaker economy, less sensitive to interest rate changes than in the past, could push rates lower and weaken the US dollar, forecasting at 1.15 and 130 by the end of 2025.

On the stock front, analysts are cautious, noting that stock markets have already made significant gains leading to anticipated interest rate cuts, leaving limited room for further growth without worsening economic news.

“Stocks are only a little cheap if you believe (as we do, but many don’t) that Gen AI will boost productivity growth by 1% from 2028,” says UBS.

The upside risk, however, is that an aggressive Fed could create the conditions for a market bubble.

“The slope of the yield curve is good for consumers (ex luxury) and for the defensive,” the bank adds. “We remain overweight these two areas (see here). Style: We think small caps outperform (3x floating rate debt vs. large caps), quality outperforms and, to a lesser extent, growth stocks.”