Yesterday’s Fed Outlook May be Best-Case Scenario for Stock Investors

But
despite
handwringing
over
the
effect
of
so-called
“higher
for
longer”
policy
on
the
economy
and
equities,
strategists
say
investors
have
reason
for
optimism.
In
fact,
our
current
scenario –
and
what’s
most
likely
to
come –
may
propel
the
powerful
bull
market,
which
has
seen
stocks
up
nearly
12%
year-to-date,
to
even
more
gains
in
the
second
half.

Treasury
Yield
and
Federal
Funds
Rate

Federal
Reserve
Economic
Database.
Data
as
of
Jun
5,
2024

What
to
Expect
From
the
Fed’s
June
Meeting

September
aside,
the
Fed
is
widely
anticipated
to
hold
rates
steady
at
the
target
range
of
5.25%-5.50%
at
its
meeting
next
week.
This
consensus
was
reinforced
by
Friday’s
robust
jobs
data,
which
Wells
Fargo
strategists
suggest
will
keep
the
Fed
in
“wait
and
see”
mode.

Anthony
Saglimbene,
chief
market
strategist
at
Ameriprise
Financial,
expects
the
Fed
to
continue
its
messaging
from
the
past
few
meetings:
“the
economy
is
holding
up,
services,
inflation
is
still
high,
and
they
won’t
be
ready
to
start
cutting
interest
rates
until
they
believe
inflation
is
moving
back
to
the
2%
target,”
he
says.

“I
think
we’re
going
to
need
to
see
a
few
more
months
of
inflation
sustainably
moving
lower
before
the
Fed
would
even
entertain
cutting
interest
rates,”
he
says.
May’s
CPI
report,
which
will
be
released
on
the
same
day
the
Fed’s
meeting
concludes,
will
give
investors
more
clarity.

When
Will
the
Fed
Cut
Rates?

When
Fed
officials
meet
on
Tuesday
and
Wednesday,
it
will
be
against
a
very
different
backdrop
than
just
a
few
months
ago.
Since
the
beginning
of
the
year,
the
outlook
for
interest
rates
has
changed
dramatically.
Investors
have
gone
from
anticipating
six
or
seven
rate
cuts
this
year
to
just
one,
or
even
none.
The
outlook
has
shifted
due
to
inflation
proving
much
stickier
than
expected
in
January,
February,
and
March.

Federal
Funds
Rate
Target
Expectations
for
December
18
2024
Meeting

CME
FedWatch
Tool.
Data
as
of
Jun
6,
2024.

However,
some
moderating
economic
data
over
the
past
two
weeks
has
investors
adding
a
little
more
easing
back
into
the
mix.
As
of
Friday,
investors
saw
a
roughly
40%
chance
of
a
single
0.25%
interest
rate
cut
by
December,
a
36%
chance
of
two
cuts,
and
an
11%
chance
of
three
cuts
by
the
end
of
the
year,
according
to
the
CME
FedWatch
tool.

Watching
the
Dot
Plots

Markets,
strategists,
and
even
Fed
officials
have
more
aligned
outlooks
for
interest
rates
now
than
at
the
beginning
of
the
year.
However,
the
release
of
the
Fed’s
June
economic
projections,
known
as
the
dot
plots,
could
upset
that
balance.

Morningstar
chief
US
economist Preston
Caldwell is
anticipating
two
rate
cuts
beginning
in
September.
Given
2024’s
rough
start
“the
Fed
is
going
to
be
cautious,”
he
says,
even
if
inflation
continues
to
improve
over
the
rest
of
the
year.
He
now
expects
GDP
growth
to
slow
gradually
over
the
next
year,
troughing
at
1.5%
in
2025.

“We
should
avoid
a
recession,
but
with
growth
slowing
well
below
its
potential
(2.5%-3.0%
over
next
couple
years),
sufficient
slack
should
be
generated
to
conclusively
win
the
war
against
inflation,”
he
writes
in
his
latest
economic
outlook.

A
Soft
Landing
is
Ideal
for
Stock
Investors

That
slowing
growth
is
not
bad,
as
far
as
the
stock
market
is
concerned.
“What
I’m
forecasting
is
probably
the
best
case,”
Caldwell
explains.
It’s
the
rare
soft
landing –
wherein
inflation
returns
to
normal
while
the
economy
avoids
a
recession.
Growth
needs
to
slow
but
remain
positive
to
accomplish
that.

Caldwell
adds
that,
in
the
short
term,
a
growth
slowdown
could
pressure
corporate
profits
and
cause
some
earnings
disappointment.
“But
that’s
going
to
be
a
temporary
speedbump
[for
stocks].
Nothing
super
concerning,”
he
says.

Ed
Clissold,
chief
US
strategist
at
Ned
Davis
Research,
has
reached
a
similar
conclusion.

“Moderating,
but
positive,
growth
would
be
the
best-case
scenario
for
equities,”
he
wrote
in
a
Thursday
note
to
clients,
adding
that
a
small
slowdown
would
favour
large
caps
rather
than
small
caps,
which
tend
to
outperform
when
growth
accelerates.
It
should
also
favour
growth
over
value,
since
growth
stocks
don’t
generally
depend
on
a
strong
economy.

US
GDP
Growth

Bureau
of
Economic
Analysis.
Data
as
of
Jun
7,
2024

Two
rate
cuts
happening
is
also
the
base
case
for
Kevin
Flanagan,
head
of
fixed
income
strategy
at
WisdomTree.
His
ideal
scenario
for
bond
investors
is
three
cuts
over
the
remainder
of
2024.
Falling
interest
rates
tend
to
be
a
headwind
for
bonds,
whose
prices
rise
as
their
yields
fall.

No
Rate
Cuts?
Stocks
Can
Take
it,
but
More
Pain
for
Bonds

Even
in
a
scenario
in
which
the
Fed
doesn’t
cut
rates
at
all
this
year,
investors
still
have
reason
for
optimism.
“The
market’s
looking
at
profit
growth
and
a
strong
economy,”
explains
Saglimbene.

While
some
cracks
are
starting
to
show,
especially
among
lower-income
consumers,
the
economy
has
thus
far
been
able
to
absorb
the
impact
of
the
central
bank’s
historic
policy-tightening
cycle.
“It’s
not
like
we’ve
seen
in
other
rate
cut
cycles
where
the
Fed
is
cutting
rates
because
of
the
economy
faltering,”
adds
Flanagan.

In
today’s
economy,
Saglimbene
says,
“if
the
Fed
isn’t
cutting
interest
rates,
it’s
because
the
economy
is
holding
up
stronger
than
expected.”
That’s
positive
for
stocks.
“Stocks
historically
perform
well
when
the
Fed
is
not
doing
anything,”
he
adds.
“We’re
in
one
of
those
periods
right
now.”

It’s
another
story
entirely
for
bond
investors.
For
Flanagan,
the
worst-case
scenario
is
that
the
Fed
doesn’t
cut
rates
at
all
in
2024.
High
interest
rates
tend
to
weigh
on
bond
prices.
If
that
happens,
“the
bond
market
is
going
to
shift
its
focus
to
2025,”
he
says.
The
Fed
remaining
data-dependent
for
longer
could
mean
more
volatility
in
fixed-income
markets
as
investors
seek
clarity
on
rates.

Flanagan
also
points
out
that
a
prolonged
period
of
bond
yields
at
today’s
levels
is
not
abnormal
over
the
past
decades,
excluding
the
15
years
when
the
Fed
kept
rates
low
following
the
financial
crisis.
“These
are
normal
yield
bubbles,
but
a
lot
of
people
aren’t
used
to
it
[…]
it’s
a
huge,
different
dynamic
in
the
market.”

Slowing
Economic
Growth
Could
Dent
Stocks

On
the
other
hand,
growth
slowing
too
much
could
cause
problems
for
stocks.
“The
stock
market
would
perform
poorly
if
these
higher
restrictive
rates
start
taking
a
more
sudden
bite
of
economic
activity,”
Saglimbene
says.
“The
bear
case
is
the
Fed
leaves
interest
rates
too
high
or
too
restrictive
for
too
long,”
thus
damaging
the
economy.

“That
could
mean
the
Fed
has
to
really
move
aggressively,”
according
to
Caldwell,
who
says
this
recessionary
scenario
is
“more
possible
than
people
think.”
He
says
it’s
even
conceivable
(though
unlikely)
that
the
federal
funds
rate
could
drop
to
zero
again.
That
may
sound
nice
for
asset
prices,
but
the
recession
precipitating
such
a
dramatic
rate
reduction
wouldn’t
be.

Sticky
Inflation
Could
Lead
to
Economic
Overheating

On
the
other
end
of
the
spectrum,
it’s
possible
economic
growth
won’t
slow
as
much
as
expected
while
inflation
remains
stickier
than
the
Fed
would
like.
The
central
bank’s
target
for
the
PCE
Price
Index
(its
preferred
measure
of
inflation
pressures)
is
2%.
As
of
April,
PCE
inflation
was
2.7%.
Caldwell
says
it
would
be
a
problem
if
inflation
stays
closer
to
3%
rather
than
continue
to
fall.

This
type
of
overheating
is
“a
very
credible
scenario
for
what
could
happen
as
a
result
of
the
internal
momentum
in
the
economy
right
now,”
he
explains.
The
resulting
uncertainty
around
the
path
of
monetary
policy
could
also
weigh
on
asset
prices.

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