Analysis: After Jumbo Fed Rate Cut, Market Hopes Ride on US Soft Landing – Reuters

By Lewis Krauskopf and Davide Barbuscia

NEW YORK – One of the most significant Federal Reserve meetings in recent memory has shifted investors’ attention to a pressing question: Has the central bank begun its rate-cutting cycle in time to prevent the economy from slowing too quickly?

On Wednesday, the Fed announced a 50 basis point rate cut, marking the first reduction in borrowing costs in over four years. Officials emphasized that this substantial move was intended to protect an otherwise resilient economy, rather than serving as a panicked reaction to recent labor market weakness. As the meeting drew near, speculation about the size of the rate cut fluctuated, with opinions nearly evenly split just before the announcement.

The success of this strategy will likely influence the performance of stocks and bonds throughout the remainder of 2024.

The concept of a “soft landing”—where the Fed successfully reduces inflation without triggering a recession—has boosted the stock and bond markets this year. However, signs of a softening labor market have raised concerns that the Fed may be acting too late to support economic growth.

"At this moment, it seems the market will pause to digest what many found surprising,” commented Eric Beyrich, co-CIO of Sound Income Strategies. “There will still be those wondering, ‘If the Fed cuts rates like that, what indicators are they seeing that we might have missed suggesting a downturn ahead?’”

Market reactions on Wednesday were relatively calm, with stocks, Treasuries, and the dollar retreating from their initial post-decision gains. The stock index ended down 0.3%, having risen as much as 1% during the session. Despite this retreat, the index remains up nearly 18% year-to-date and is close to a record high.

Following the announcement, Fed Chair Jerome Powell characterized the move as a “recalibration” in light of significant declines in inflation since last year. He emphasized the central bank’s intention to proactively manage any potential job market weaknesses.

Not all investors shared Powell’s optimistic view.

“Despite Powell’s reassurances during the press conference, the 50 basis point cut suggests concern that they may not be acting quickly enough,” remarked Josh Emanuel, chief investment officer at Wilshire. Emanuel indicated that he was already inclined towards bonds before the meeting, preferring investment-grade credit over riskier high-yield options due to expectations of an economic slowdown.

Other investors, however, viewed the rate cuts as a beneficial development that would provide support to the economy.

"I believe this significantly enhances the Fed’s chances of achieving a successful soft landing, which should, in turn, be positive for risk assets," noted Jeff Schulze, head of economic and market strategy at ClearBridge Investments.

Historically, stocks have performed well after rate cuts, provided the economy does not slip into recession. Data shows that the S&P 500 tends to gain an average of 14% in the six months following the first cut of a rate-cutting cycle during non-recessionary periods. In contrast, the index has recorded a 4% decline in similar circumstances when a recession is already underway.

Rick Rieder, chief investment officer for global fixed income at BlackRock, mentioned that investors might have overreacted to recent labor market reports, which came in weaker than expected. He pointed out that other economic indicators, like GDP growth estimates, still reflected a strong economy.

"I think the markets may have jumped the gun in interpreting the data as excessively weak," he stated. "Chair Powell described it as a solid economy, and I agree."

In terms of future outlooks, Fed officials updated their interest rate projections from their June estimates, anticipating deeper cuts, although their rate forecasts remained above market expectations for a more accommodating approach. The Fed indicated that it expects the federal funds rate—which currently stands between 4.75% and 5%—to drop to 3.4% by the end of next year, while market traders are anticipating around 2.9%. Additionally, the Fed slightly upgraded its endpoint for rate cuts to 2.9% from 2.8%.

This disparity in outlook may have contributed to a shift in Treasury markets, resulting in a selloff of longer-term Treasuries following the announcement. The benchmark yield, which moves inversely to bond prices, settled at around 3.73 after earlier reaching its lowest level since mid-2023.

"In terms of how quickly cuts were incorporated into market pricing, I think this is a reasonable reaction," said John Madziyire, head of U.S. Treasuries and TIPS at Vanguard, who anticipated a rise in long-term yields.

Some investors are also contemplating the potential influence of the upcoming U.S. presidential election on the trajectory of rate cuts.

If trade tensions were to escalate under a new administration, it could adversely affect fixed income markets, according to Andrzej Skiba, head of U.S. fixed income for RBC Global Asset Management. "That could be inflationary and limit the Fed’s capacity to lower rates," he concluded.