Title: Federal Reserve's Interest Rate Cuts: What Investors Need to Know for Economic Data Analysis and Stock Market Strategy
By Lewis Krauskopf
(Multibagger) - With interest rate cuts practically a foregone conclusion, investors are zeroing in on upcoming economic data to determine if the "soft landing" narrative that has driven U.S. stocks in 2024 can sustain itself.
Federal Reserve Chair Jerome Powell announced on Friday that the "time has come" to start reducing interest rates—a more dovish stance than many investors expected at the Fed’s annual conference in Jackson Hole, Wyoming. The process is likely to commence next month, with a 25 basis-point cut anticipated at the Fed’s monetary policy meeting on Sept. 17-18.
However, Powell's comments are not an all-clear signal. With the S&P 500 up 18% this year and equities richly valued, market participants need continued evidence that the economy is smoothly transitioning to a soft landing, characterized by resilient growth and cooling inflation.
"What the market wanted was to hear that the rate-cutting cycle is starting," said Alessio de Longis, senior portfolio manager and head of investments at Invesco Solutions. However, he added, “Is the Fed signaling concerns about the economy? If so, perhaps the excitement around the cutting cycle should be reconsidered."
Historically, stocks perform significantly better when rate cuts occur amid resilient growth rather than during sharp economic slowdowns. Since 1970, the S&P 500 has averaged an 18% gain one year after the first rate cut in non-recessionary periods, according to Evercore ISI strategists. In contrast, the index has averaged just a 2% gain in recession periods following the first cut.
Powell emphasized that the Fed neither sought nor welcomed further labor market cooling and aimed to prevent further erosion. Therefore, jobs will be in the spotlight when the U.S. publishes a closely watched employment report on Sept. 6, following weaker-than-expected labor market data earlier in August.
Other significant upcoming data includes two monthly inflation reports: the personal consumption expenditures price index on Aug. 30 and the consumer price index on Sept. 11.
If the economic data shows more signs of weakness, it could unsettle stocks and shift expectations towards a 50 basis-point cut next month. Futures data on Friday afternoon indicated a 35% likelihood of a 50-bp cut, up from 29% before Powell's speech, with the remaining expectations favoring a 25-bp cut.
"The Fed is easing even though the economy isn't particularly weak (and inflation remains above target), and it has the potential to ease substantially in response to any acute weakness," wrote Rick Rieder, BlackRock’s chief investment officer of global fixed income.
Quincy Krosby, chief global strategist at LPL Financial, noted that a critical factor for stocks is whether rate cuts are due to moderating inflation or a weakening labor market. "The market wants a rate-cutting cycle because inflation is coming down," Krosby said. "The question remains whether we will see further deterioration in the labor market."
Encouraging economic data could also bolster stocks during a period some expect to be turbulent. Historically, September is the weakest month for stock performance, with the S&P 500 averaging a 0.78% decline since World War Two, according to CFRA data.
Elevated stock valuations may also make investors less inclined to hold onto equities if bad news emerges. The forward price-to-earnings ratio for the S&P 500 is at 21, up from 19.6 in early August, according to LSEG Datastream. The index’s long-term average is 15.7.
A tight presidential race between Vice President Kamala Harris and former President Donald Trump is likely to add to market uncertainty leading up to the Nov. 5 election.
"The longer-term trends in stocks are rock-solid, and any weakness is an opportunity to add exposure," said Andre Bakhos, managing member at Ingenium Analytics LLC. In the shorter term, "we're going to experience choppy, erratic, volatile moves because no one really knows what will happen now that Powell has shown his hand."
Analysis for Everyone:
In simpler terms, the Federal Reserve (the central bank of the U.S.) is planning to lower interest rates, starting likely next month. This news has made many investors optimistic because lower interest rates usually make borrowing cheaper, which can boost economic activity and stock prices. However, it’s important to watch upcoming economic reports on jobs and inflation. If the economy shows signs of weakness, it could lead to bigger interest rate cuts, but it might also make stock prices more volatile. Overall, while there is potential for gains, the market could be unpredictable in the short term, especially with an upcoming presidential election adding to the uncertainty.