Stock Market Urges Fed for Interest Rate Reduction

The Stock Market Cheers Hope for Fed’s Interest Rate Pause, but Faces Cautionary Tale Amid optimism—and perhaps reality—regarding the Federal Reserve’s decision to halt interest rate hikes in June, the stock market has experienced a rally. While the market is currently in favor of rate cuts, it should exercise caution in its desires.

Since reaching a bear market low in early October, where buyers made aggressive moves and anticipated the Fed’s halt in rate hikes due to declining inflation, the S&P 500 has surged by approximately 15%. The purpose of rate hikes is to curb inflation by reducing economic demand.

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The effectiveness of previous rate hikes is evident: Consumer prices rose less than the predicted 5% year-over-year in April. Furthermore, the market is already predicting an 87% probability that the Fed will maintain the current rates in June through the Fed funds futures market.

Investors must now consider an alternative scenario: In light of rapidly declining inflation and concerns about the short-term economic consequences of high rates, the Fed may opt to slash rates this summer. Currently, the fed funds futures market indicates a 36% likelihood of a rate cut in July.

However, rate cuts may not yield the desired outcomes for the market, as expected by Wall Street. While lower rates could stabilize the U.S. economy and promote growth after potentially entering a recession, the initial economic impact may be worse than anticipated, thereby adversely affecting companies’ earnings results.

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Indeed, according to Credit Suisse, the S&P 500 typically experiences a decline in the six months following the Fed’s first rate cut. Jonathan Golub, the bank’s chief equity strategist, noted that “while a lower funds rate is often believed to support higher stock prices, it is also a sign that the economy is faltering.”

On the other hand, Credit Suisse’s research shows that the S&P 500 typically experiences a rally in the six months following the last interest rate hike when there are no anticipated cuts. If the Fed pauses rate hikes without planning any cuts, it signifies a decline in inflation alongside stable economic growth—a win-win situation for stocks.

Investors may not welcome this perspective, but it’s important to acknowledge that the market is not yet free from challenges.