With Fed easing underway, what’s next for markets? UBS Weighs In By Investing.com

Investing.com — The Federal Reserve’s recent decision to cut interest rates by 50 basis points (bps) marks an aggressive policy shift as Chairman Jerome Powell emphasized the central bank’s commitment not to fall “behind the curve.”

This initial rate cut to 50 provided some relief to investors, indicating that the Fed is prepared to act decisively if economic conditions weaken.

According to UBS, this move could be seen as a reactivation of the Fed’s “put”, where further rate cuts could be triggered if data, particularly on the labor market, starts to deteriorate. Markets have responded positively, but the focus now turns to the effectiveness of these cuts and whether they can ensure a soft landing for the US economy.

While UBS sees a soft landing as likely, investor confidence in an extended economic expansion will depend on future data, particularly labor market indicators such as September’s payrolls report.

Looking beyond the immediate future, UBS notes that the debate now centers on the terminal or neutral rate — how much the Fed will cut this cycle.

While the soft landing scenario does not depend on rates falling to 3% or 3.5%, the outlook for the neutral rate reflects broader questions about the post-pandemic economy. UBS highlights the possibility of a “roaring 20s” regime, marked by stronger growth and inflation than pre-pandemic norms, as an underappreciated growth risk.

For now, economic data remains solid, with Q3 growth estimates around 2.5%-3%. UBS suggests that investors are increasingly comfortable with a macro environment of preemptive rate cuts, steady disinflation and moderate growth. However, uncertainties remain, particularly regarding the longer-term trajectory of the US economy and the eventual neutral rate.

“Powell described the rate cut as a ‘recalibration’ of policy to make it less restrictive, and investors may need to recalibrate their own expectations for the terminal/neutral rate,” UBS said in a note.

“It is highly unlikely that the Fed will only cut 75 bps in total this cycle – 100 bps this year seems almost certain. But the outlook for 2025 is quite open, especially with an uncertain post-election fiscal policy,” he added.

The bank concludes that while markets have priced in the soft landing, volatility could re-emerge as investors wait for clearer signs of the soft landing extending into a more prolonged period of economic growth.