Rate Cuts are Near. What’s Next for Markets?
Last Friday, Fed Chair Jerome Powell delivered his highly anticipated speech in Jackson Hole, Wyoming. “The time has come for policy to adjust,” he said in the address. “The direction of travel is clear, and the timing and pace of cuts will depend on incoming data, the evolving outlook and the balance of risks.” Those two sentences leave little up to interpretation and signal the Fed’s plan to initiate a cycle of rate cuts – a significant moment for financial markets.Reaction to the speech, as indicated by fed fund futures, shows a strong expectation of imminent rate cuts. The market is pricing in a 100% probability of at least a 25 basis point (0.25%) cut in September, with a 35% chance of a more substantial 50bps (0.50%) cut as of August 29. Looking ahead, the market anticipates a total of 100bps (1.00%) in cuts through 2024 with further reductions expected in 2025. The implied fed funds rate would reach around 3% by the end of 2025, down from the current range of 5.25-5.50%.
This suggests that the market expects the Fed to start cutting rates as soon as possible and to continue through 2025. Such expectations are relatively aggressive and suggest that the market either anticipates a slowdown in economic activity or believes the Fed will act preemptively to sustain positive growth.
History tells us the impact of a rate-cutting cycle on the stock market is complex and context-dependent. When the Fed cuts rates in a strong economy, equity markets tend to respond positively. According to a study by Evercore ISI, the S&P 500 has climbed on average 18% one year after the first cut in non-recessionary periods and 2% in recession periods since 1970.
The current state of the U.S. economy appears solid in several respects. Inflation is trending downward, consumer spending seems to be strengthening and corporate earnings have generally exceeded expectations. Additionally, the Atlanta Fed’s GDP tracker forecasts a 2.0% growth rate for Q3, indicating continued economic expansion.
However, there are areas of concern within the economy, particularly in the labor market. The unemployment rate has increased from a cycle low of 3.4% to 4.3%, signaling a slow but steady weakening. Powell addressed this in his speech, saying that “the downside risks to employment have increased.” These concerns tie back to the Fed's dual mandate of promoting maximum employment and price stability.
We discussed the Fed’s dual mandate in the July 12 edition of Investment Insights. Click here to read the commentary.
The Federal Reserve's upcoming decisions on rate cuts will play a pivotal role in shaping the economic and market outlook. Powell's speech has set the stage for more accommodative policy moving forward, with the market anticipating significant easing.
While historical trends suggest that rate cuts in a robust economy often lead to strong equity market performance, the current environment is complex. The U.S. economy shows resilience in many areas, but the weakening labor market introduces uncertainty.
Investors will need to closely monitor economic data and Fed signals to gauge if the expected rate cuts will support continued growth or if they signal deeper concerns about the economy's trajectory. The balance between managing inflation, supporting employment and sustaining growth will be critical as the Fed navigates this delicate transition.
