Analysis: Following Major Fed Rate Cut, Markets Pin Hopes on a U.S. Soft Landing.Cau

By Lewis Krauskopf and Davide Barbuscia

NEW YORK (Reuters) – The recent Federal Reserve meeting has put a spotlight on a critical question for investors: Has the central bank initiated its rate-cutting cycle in time to avert a significant economic slowdown?

On Wednesday, the Fed announced a 50 basis point rate cut, marking its first reduction in over four years. The central bank characterized this sizable cut as a proactive step to support a resilient economy, rather than a reaction to recent labor market weaknesses. In the days leading up to the meeting, speculation about the size of the cut had been nearly evenly split.

The implications of Fed Chair Jerome Powell’s outlook will likely be a major factor influencing stock and bond performance for the remainder of 2024. The prospect of a “soft landing,” where inflation decreases without triggering a recession, has bolstered market sentiment this year. However, signs of a weakening labor market have raised concerns that the Fed may have acted too late to bolster growth.

“Currently, it seems the market will take a moment to digest what many find surprising,” said Eric Beyrich, co-CIO of Sound Income Strategies. “There will be speculation about what the Fed knows that suggests the economy may be deteriorating.”

Market reactions on Wednesday were somewhat muted, with stocks, Treasuries, and the dollar reversing initial gains after the announcement. The S&P 500 closed down 0.3%, despite an earlier rise of up to 1%. The index is still up nearly 18% for the year, approaching record highs.

Following the decision, Powell described the rate cut as a “recalibration” in response to significant declines in inflation and emphasized the need for caution regarding potential weaknesses in the job market.

Some investors expressed skepticism about this optimistic viewpoint. “Despite Powell’s comments, a 50 basis point cut indicates there are concerns about being behind the curve,” said Josh Emanuel, chief investment officer at Wilshire. He has shifted his focus toward investment-grade bonds, anticipating economic deterioration.

However, many believe that the rate cuts will provide a positive boost to the market. “This increases the likelihood that the Fed can achieve a soft landing, which is bullish for risk assets,” said Jeff Schulze, head of economic and market strategy at ClearBridge Investments. Historically, the S&P 500 tends to gain an average of 14% in the six months following a rate cut during a non-recessionary period, compared to a 4% decline when the economy is in recession.

Rick Rieder, chief investment officer for global fixed income at BlackRock, noted that investors might have overreacted to recent weaker labor market reports, highlighting that GDP growth estimates still indicate a robust economy. “Chair Powell described it as a solid economy, and it is,” he stated.

LONG-TERM ADJUSTMENTS

Fed officials have updated their interest rate forecasts, indicating deeper cuts ahead. They now anticipate the Fed funds rate to reach about 3.4% by the end of next year, while market participants expect it to be closer to 2.9%.

This divergence in expectations led to a selloff in longer-term Treasuries, with the benchmark 10-year Treasury yield rising to approximately 3.73%, after having hit a low earlier in the week.

“In terms of the pace of cuts, the market’s reaction is justified,” commented John Madziyire, head of U.S. Treasuries at Vanguard.

Looking ahead, the outcome of the upcoming U.S. presidential election may further complicate the rate-cutting path. “If trade wars were to escalate under a Trump presidency, it could have negative implications for fixed income,” warned Andrzej Skiba, head of U.S. fixed income for RBC Global Asset Management. “That would be inflationary and limit the Fed’s ability to cut rates.”

(Reporting by Lewis Krauskopf and Davide Barbuscia; Additional reporting by Suzanne McGee; Editing by Ira Iosebashvili and Muralikumar Anantharaman)