Potential Aggressive Fed Rate Cut Next Week May Backfire and Target Big Tech

Investing.com — According to BCA Research, if the Federal Reserve implements significant rate cuts next week while the economy appears to be performing well, it could result in negative consequences for the market rather than provide the expected support.

BCA notes that a larger rate cut during a period of stable economic growth could raise concerns about the economy. A key factor in why aggressive rate cuts could backfire is the yen carry trade, which has seen traders borrow yen at low interest rates to invest in higher-return assets like stocks. This trade relies on the belief that the Bank of Japan will maintain its accommodative monetary policy amid ongoing challenges related to deflation and weak economic conditions.

BCA argues that unwinding the yen carry trade, which is closely linked to the valuations of major tech companies, could significantly impact these firms. This scenario may prompt further calls for aggressive cuts, potentially leading to the very recession that the Federal Reserve is trying to avoid.

The relationship between big tech and the yen is described by BCA as “reflexive.” The increasing value of major tech stocks has made them attractive for the yen carry trade, while the rising valuations of these tech firms have likely depended on leverage obtained through borrowing yen at nearly zero interest rates.

BCA warns that aggressive rate cuts could weaken the U.S. dollar, resulting in a stronger yen and consequently causing a decline in U.S. tech stock valuations relative to bonds.

Concerns about a potential recession are not unfounded, as bond traders seem to be bracing for a softer economic landing. The current U.S. interest rate curve suggests expectations of a significant recession within the next six months, with forecasts indicating a discount of 170 basis points in rate cuts in the February 2025 Fed funds contract.

This suggests that at least two half-point rate cuts may occur in the next five policy meetings, a pace typically observed only during recessionary periods.

The Federal Reserve is set to begin its meeting on September 17, where a 25 basis point rate cut is widely anticipated.