Will the end of the Federal Reserve's interest rate hike cycle ignite a new market trend? This time may be different
The Federal Reserve is expected to hold its interest rate meeting this week, and the market generally expects it to remain stagnant.
Since March 2022, the Federal Open Market Committee has cumulatively raised interest rates by 525 basis points. The pricing of federal funds rate futures shows that the probability of further interest rate hikes in the future remains around 40%, and the Federal Reserve may end its most aggressive tightening cycle in nearly 40 years.
BK Asset Management macro strategist Schr ö sberg stated in an interview with First Financial that the Federal Reserve's suspension of interest rate hikes this week is firmly established. Although energy prices pose a certain risk of price fluctuations, the continued cooling of core inflation is a positive signal. "The Federal Reserve is likely to choose to patiently wait and observe the release of the impact of monetary policy, which also means that the current interest rate hike cycle has ended. However, when the Federal Reserve will cut interest rates remains to be seen, and there is great uncertainty about the future inflation path," he said.
Historical data shows that the turning point of monetary policy is often the starting point of the US stock market. Currently, institutions generally predict that corporate profits have bottomed out. However, considering the uncertainty of the inflation path, the success of a "soft landing" will be crucial.
Profit bottoming out valuation to be repaired
According to statistics from financial research firm CFRA, during the past six credit tightening cycles of the Federal Reserve, the S&P 500 index saw an average increase of 13% from the last rate hike to the first rate cut in the next cycle. "If Wall Street concludes that the Federal Reserve has ended its interest rate hike plan, it will at least provide important confidence support and psychological implications for the market," said Stovia, chief investment strategist at the institution
Not only that, CFRA also found that the Federal Reserve typically lowers interest rates for nine months after the last rate hike, and the S&P 500 index can still rise by 6.5% within six months after the rate cut. This is also in line with current market expectations. According to data from the Chicago Mercantile Exchange's interest rate observation tool FedWatch, June next year may be a potential easing point for the Federal Reserve.
US stock market profits will resume growth
From the just passed second quarter financial report, companies are also optimistic about the economic outlook. According to FactSet's analysis of conference call records, executives are discussing economic downturns less and less frequently. "The number of S&P 500 index constituent companies citing 'recession' in the conference call has been declining for four consecutive quarters.". The institution has adjusted its profit forecast for the third quarter to a growth of 3.6%, which means that the current round of decline in US stock profits has come to an end, and it is expected to reach around 10% in the fourth quarter and next year, which to some extent reflects confidence in economic recovery. Although overall inflation in the United States remains around 4%, consumer spending continues to grow steadily supported by excess savings and strong demand in the labor market.
Schlossberg told First Financial that profit growth is crucial for whether the US stock market can go further in the future. "From the current valuation level, the 12 month forward P/E ratio of the S&P 500 index is about 18.5 times, significantly higher than the long-term average of 15.6 times. At the same time, valuation is also suppressed by US bond yields, with benchmark 10-year US bonds at their highest levels since the financial crisis," he said.
It is worth mentioning that JPMorgan Chase recently issued a warning, stating that the market is "overly optimistic" about the overall profit outlook of US companies. Kolanovich, a star analyst and chief global market strategist at the bank, said that the second quarter financial report did not leave a deep impression on people, and the financial outlook is not so optimistic because the Federal Reserve has pushed up borrowing costs, reduced consumer savings, and trapped overseas economies.
"Considering the aging business cycle, monetary policy is very strict, capital costs are still rising, coupled with a decline in consumer savings and household liquidity, as well as an increased risk of recession in some of the largest economies abroad, there are a series of unfavorable factors." Kolanovich's analysis shows that although the resilience of the US economy is better than many developed countries, it cannot avoid the potential damage caused by interest rate hikes. "When the market no longer has fear and only becomes complacent, it is often a dangerous time.".
Schr ö sberg believes that the bottom of US stock profits is also related to a low base in the same period last year, when the Federal Reserve was in the early stages of a rate hike cycle. For enterprises, whether their performance can continue to be released is facing a test, especially considering that the economy will gradually slow down, the pressure is obviously enormous.
There is uncertainty in "soft landing"
Since August, the US stock market has fallen into a temporary downturn, with the uncertainty of a comeback becoming a disruptive factor in addition to traditional seasonal factors. The market is concerned that future economic growth slowdown and inflation stickiness may lead to stagflation, which is in stark contrast to the ideal scenario of a "soft landing" of declining inflation and stable economic growth.
The minutes of the Federal Reserve's July meeting show that it has abandoned its previous judgment of a mild recession and is preparing for a "significant slowdown in growth rate" situation. Since the beginning of this year, the performance of US stocks has been strong, partly due to the resilience of the US economy in the face of high interest rates. Considering that the Federal Reserve has not relaxed its stance on interest rate cuts, many views believe that a recession under long-term tightening conditions is only a matter of time.
Hartnett, Chief Strategist of Bank of America, said that maintaining the federal funds rate at a higher level for a longer period of time will weaken the possibility of a "soft landing". He believes that oil prices, US dollars, and bond yields are still at high levels, and the tightening financial environment is where the risks lie.
On the other hand, economic recession and rising unemployment rates may lead to an increase rather than a decrease in long-term US Treasury yields, and the market underestimates the destructive power of fiscal policy panic. Hartnett added that US Treasury yields may rise to punitive levels, leading to a long "hard landing". He said that investors can consider taking advantage of any rebound in risk assets in the coming months to defend themselves and prepare for a "hard landing".
Deutsche Bank stated this month that although a "soft landing" is still possible, the Federal Reserve needs to restrain demand below potential levels to lower inflation rates to its target of 2%, and the sharp rise in credit card debt is a double-edged sword for the economy. Deutsche Bank reiterated its previous view that the likelihood of the US economy falling into recession within the next year is higher. "Given that the inflation rate remains significantly above the target, the Federal Reserve's policy risk may lean towards being too tight." The report warns that data may indicate that as the impact of tight monetary policy becomes apparent, the US economy will face greater pressure in early 2024.
Chief US stock strategist Bannister, who accurately predicts the trend of US stocks in the first half of the year, has changed his previous optimistic view and expects the S&P 500 index to remain largely unchanged from its current level by the end of this year, as sustained inflation rates above target will lead to the Federal Reserve maintaining its tightening policy. Bannister said that if S&P wants to break through historical highs, in addition to a significant improvement in corporate financial conditions, monetary policy also needs to be more friendly. However, the Federal Reserve may not do so temporarily because inflation rates may be more stubborn than expected in the future.