The Fed is unlikely to cut interest rates this year. Why it’s good news for the markets
New York (CNN) Wall Street is eager to see the Federal Reserve unwind its aggressive rate hikes cycle that hit markets and tested investor morale. Although a pause in rate hikes seems likely, cuts may be further away than some think.
The stock The market has remained resilient this year after a brutal 2022 marred by persistent inflation, Federal Reserve interest rate hikes, Covid shutdowns and geopolitical tensions.
Nevertheless, investors have been hypervigilant for signs that the central bank may give up its rapid interest rate hike. Fed issued its tenth interest rate increase in a row in May, raising the interest rate by a quarter of a point. The central bank also opened the door to a break, accelerating bets that The Fed will hold interest rates stable at the next meeting in June and cut interest rates as soon as July.
But experts say the Fed is unlikely to cut interest rates anytime soon, at least if the economy stays warm (all bets are off if the US defaults). A pause in interest rate increases may actually be better for shares than a cut, they say.
It is unlikely that the Fed will cut interest rates in July
Experts say the Fed will not cut interest rates for the first of two main reasons: Inflation remains sticky, and the economy has remained strong.
Although prices are stabilizing, inflation remains well above the Fed’s 2% target. The personal consumption expenditures price index, the Fed’s preferred inflation gauge, rose 4.2% for the 12 months ended in March.
At the same time, US unemployment is at a record low. The US housing market is cooling, but low inventory and persistent demand are pushing house prices up in some parts of the country.
In other words, there is nothing – at least not yet – to convince the Fed that it should move to lower interest rates.
“The Fed rarely cuts interest rates without some sort of crisis in between,” said Kara Murphy, chief investment officer at Kestra Investment Management.
The Fed last cut interest rates after an emergency meeting in March 2020, when the outbreak of the Covid-19 pandemic sent US markets plunging into the first bear market in 11 years and sparked panic that the global economy could tip into a deep recession.
The collapses of Silicon Valley Bank, Signature Bank and First Republic Bank this year fueled fears that the banking sector could face more turmoil and credit standards would tighten. But the turmoil has largely been confined to regional banks, and both financial and economic leaders have argued that the banking sector remains stable.
A serious turn for the worse in the banking sector, an implosion in the labor market or a similar downturn for the economy will have to happen for the central bank to lower interest rates in July, says Liz Ann Sonders, investment strategist at Charles Schwab.
“The Fed would lose what credibility they have left if they went from hiking to cutting for no reason,” Sonders added.
Would a July cut bonus shares?
Even if the Fed were to cut interest rates soon, an immediate bull run is not guaranteed.
History shows that stocks tend to perform tepidly after a pivot to rate cuts compared to a pause: S&P 500 (SPX) have historically risen 16.9% on average in the 12 months following the last hike in a Fed rate cycle and fell 1% in the 12 months after the central bank first cut rates, Credit Suisse said in a May 9 note .
“Assuming the May 3 rate hike was the last in this cycle, stocks should perform fairly well through the rest of the year. But if the Fed were to ease in July — as futures suggest — the upside will be far more limited,” the analysts said.
Cutting interest rates too soon can have serious consequences for the economy.
Between 1972 and 1974, then central bank governor Arthur Burns increased interest rates dramatically. He then cut them back as the economy tanked.
As inflation later rose higher, the Paul Volcker-led Fed took drastic action to push interest rates up to tame it. Effective Fed funds rates topped 22% at their peak in July 1981, and the central bank’s aggressive tightening helped trigger back-to-back recessions that drove unemployment as high as 10%.
Powell acknowledged the missteps in a speech in August in Jackson Hole. The Fed has since signaled it is unlikely to cut interest rates this year and reaffirmed its commitment to curb inflation.
“I don’t think the Fed is going to be in a hurry to cut rates this time,” said Marco Pirondini, head of U.S. equities at Amundi.
that’s not to say that a Fed rate cut this year is completely off the cards, says Nicole Webb, senior vice president at Wealth Enhancement Group. The Fed will eventually want to cut interest rates again, but it likely won’t do so at the historic pace at which it has raised them the last year, she says.
“They can slowly pace us down to 2.5% without the inflation monster rearing its ugly head again,” Webb said. “And I actually think it’s possible.”