The market is currently pricing in 96 basis points of easing in 2024, or roughly four quarter-point cuts. Let’s say the Federal Reserve doesn’t cut rates at all, what would happen to markets?
Now obviously the market likes lower rates because cheaply borrowing and levering up has been the first page of the investing playbook for the past 15 years. So the inclination would be to see the lack of cuts as negative.
Tuesday was certainly an indication of that as the S&P 500 fell nearly 2% before a curious late-day bounce. But today’s price action tells a different story as stocks have rebounded.
I think there’s a message there and it’s that stock markets wouldn’t necessarily sink if the Federal Reserve didn’t cut rates. There would certainly be some volatility but I don’t think it would be a disaster.
That’s because if the Fed didn’t cut rates, it would mean that the economy was still strong. Say there are two options:
- The US economy grows 3.5%, inflation finishes the year at 3% and rates stay at 5.25-5.50%
- The US economy grows 1.5%, inflation finishes the year at 2% and rates fall to 4.25-4.50%
In many ways, option #1 is a better one for equity markets. It would leave GDP in a better place, ensure a stronger labor market and leave the Fed with 525 bps of dry powder.
Now if we end up in situation with 1.5% growth (or less) and 3% inflation (or higher), that’s obviously bad but if the Fed gets hung up on the ‘last mile’ on inflation and growth stays strong, I don’t see a big problem. That kind of scenario would also be a great one for the US dollar because growth is not on that level elsewhere.
The market increasingly sees high rates as a Fed put and isn’t concerned about a true re-ignition of inflation. Now that could prove to be foolish but right now that’s the message from the market. It’s a strong economy with a Fed put. If growth is good, that’s great. If growth stumbles, the Fed will be there to ensure all is well.
This article was written by Adam Button at www.forexlive.com. Source