One of the most consequential US Federal Reserve meetings in recent history has put investors’ focus squarely on one question: Whether the central bank has kicked off its rate-cutting cycle in time to keep the economy from slowing too rapidly.
The Fed delivered a 50 basis point rate cut on Wednesday — lowering borrowing costs for the first time in more than four years — and assured investors the larger-than-usual-sized reduction was a measure to safeguard a resilient economy, rather than an emergency response to recent weakness in the labor market.
Bets on the size of the rate cut swung in the days before the meeting and were near an even split on Wednesday morning.
Photo: EPA-EFE
The degree to which Fed Chairman Jerome Powell’s outlook pans out is likely to be a key factor in the trajectory of stocks and bonds for the remainder of this year.
Prospects of a “soft landing,” where the Fed brings down inflation without pushing the economy into recession, have lifted stocks and bonds this year. However, signs of a softening labor market have fueled worries that the Fed might be too late in acting to shore up growth.
“Right now, it looks as if the market is going to pause to digest what was to many a surprise,” said Eric Beyrich, co-chief investment officer (CIO) of investment advisory firm Sound Income Strategies.
“There will still be people thinking, ‘wow, If the Fed cuts big like that, what do they see that we’re not seeing that suggests the economy will get worse?’” he said.
Market reaction on Wednesday was relatively subdued as stocks, Treasuries and the dollar retraced initial, post-decision rallies.
The S&P 500 ended down 0.3 percent, after rising as much as 1 percent during the session. The index is up nearly 18 percent this year and stands near a record high.
In comments following the decision, Powell called the move a “recalibration” to account for the sharp decline in inflation since last year.
The central bank wanted to stay ahead of any potential weakening in the jobs market, Powell said.
Some investors were skeptical.
“Despite what Chair Powell is saying in the press conference, a 50 basis point move does indicate that there is concern that they are behind the curve,” said Wilshire CIO Josh Emanuel.
Emanuel said he was already overweight bonds coming into the meeting, favoring investment-grade credit over riskier high-yield bonds ahead of an expected deterioration in the economy.
Many others, however, believed the rate cuts were a positive development for the market and would buoy the economy.
“I think that this dramatically increases the odds of the Fed being able to stick the landing, which ultimately will be bullish for risk assets,” said Jeff Schulze, head of economic and market strategy at ClearBridge Investments.
Indeed, stocks have performed well following rate cuts — as long as the economy stayed out of recession.
The S&P 500 has posted an average 14 percent gain in the six months following the first reduction of a rate-cutting cycle during a non-recessionary period, data from Evercore ISI going back to 1970 showed. That compares to a 4 percent decline in the period after an initial cut during a recession.
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