Daily Management Review

Prospects Of A Rate Drop Might Boost US Equities While Investors Wait For Earnings And Elections


Prospects Of A Rate Drop Might Boost US Equities While Investors Wait For Earnings And Elections
Following a surge in U.S. equities, which might soon be put to the test by impending corporate earnings reports and escalating political unpredictability, the likelihood of short-term interest rate reductions is supporting the argument for investors to be positive.
With Fed Chair Jerome Powell telling Congress that the U.S. is "no longer an overheated economy," expectations that the Federal Reserve would begin its eagerly anticipated cycle of rate cuts in September remained stable on Tuesday. This suggests that the argument for loosening monetary policy is becoming stronger.
Rate-cut bets have seen significant volatility this year, but they are hardly the only reason contributing to the S&P 500's 17% year-to-date gain. Other variables include robust profits and enthusiasm surrounding artificial intelligence.
However, a lot of investors think that more clarity on the Fed's timeline for starting to loosen monetary policy and the potential extent of rate cuts in 2024 might act as a safety net for equities in the event that the markets become erratic in the following months.
Rate reduction will start as a show that "the Fed has the market's back," according to BMO Wealth Management's chief investment officer, Yung-Yu Ma. He anticipates around six rate reductions from the central bank in the upcoming year. He stated, "We believe that to be a positive factor for the economy and the markets."
According to CME FedWatch, as of late on Tuesday, investors were pricing in a probability of over 70% that the Fed will lower rates in September, up from about 50% a month earlier.
Based on LSEG data, fund funds futures are factoring in around 50 basis points of total easing in 2024.
According to Peter Cardillo, chief market economist at Spartan Capital Securities, "the Fed is getting closer to cutting rates." "I think there will be two rate cuts this year: one in December and one in September."
Powell said before the Senate Banking Committee that although inflation has decreased recently, "more good data would strengthen" the argument in favour of looser monetary policy.
The U.S. consumer pricing statistics for June will be released on Thursday, marking one early test. Although the previous few reports have shown that inflation is beginning to decline, an unexpectedly high figure may make the case against further easing in the months ahead less compelling.
On the other side, market confidence may be bolstered in the face of several possible hazards in the upcoming weeks by predictions of impending monetary easing in conjunction with declining inflation and steady GDP.
Friday marks the start of corporate earnings season, which could have an impact on the highly valued U.S. share market if firms fall short of high expectations. Reports from large banks will be released first. LSEG IBES projects that S&P 500 firms' earnings will rise by 10.6% this year and 14.5% in 2025.
Investors are also prepared for the unpredictable course of the U.S. presidential election, given that calls for the incumbent to resign were sparked by President Joe Biden's unimpressive debate performance against former President Donald Trump late last month.
In a recent midyear forecast, Truist Advisory Services co-chief investment officer Keith Lerner expressed his continued optimism for U.S. equities, while anticipating markets to move "in a choppier fashion" after a robust first half.
"After the post-pandemic stimulus boom, U.S. economic growth is now cooling, but it is still strong," he stated. As long as the economy stays out of recession, stocks have historically increased in the six to twelve months that follow the Fed's initial rate decrease, according to Truist's study.
A few megacap firms like Nvidia have led the equities rise; lower interest rates may contribute to the surge's expansion. According to BofA Global Research strategists, the first half of the year saw only 24% of S&P 500 equities beat the index, marking the third-narrowest six-month period since 1986.
Lower rates, according to Matt Miskin, co-chief investment strategist at John Hancock Investment Management, might benefit market segments that have been negatively impacted by higher rates as big tech has grown. This includes small-cap businesses, who rely more heavily on funding and are therefore typically more vulnerable to interest rate changes. The small-cap Russell 2000 has gained just 0.1% so far this year.
"In many cases, smaller-cap companies require capital to survive, and this higher cost of capital makes their business really challenging," the speaker stated. "Those companies would definitely benefit from a lower cost of capital."
Of fact, rate reductions are not always a sign of easy sailing; they frequently occur when the Fed is compelled to quickly loosen monetary policy in response to a worsening
According to a Wells Fargo Investment Institute report published last month, the S&P 500 has lost 20% of its value on average over the 250 days that follow a cycle's initial reduction.
The experts at the business said that if the Fed lowers rates in response to declining inflation, stocks would probably do well over the following six to eighteen months.
But they added, "we would expect stock performance to suffer if the Fed is forced to cut aggressively in response to a macro or market disruption."