The questions on many people’s minds are 1.) “What will the Fed do with rates?” and 2.) “How will that affect the stock market?”. As of this writing, the market is pricing in about a 66% chance of a 0.25% cut and a 34% chance of a 0.50% cut at the September 18th meeting according to the CME Group. We don’t have any edge in knowing what the Fed will do, and we don’t think investors can profitably out-guess the market when it comes to such events. The second question, which is more important, ultimately depends on the strength of the economy.
All else equal, it is better for the market to have falling interest rates rather than rising ones. But the Fed isn’t cutting rates in a vacuum; recent weakness in the labor market has been a key part of Jerome Powell’s decision to change interest rate policy. If the economy continues to weaken and falls into a recession, then Fed rate cuts will not be enough to stop a market decline. But if the labor market stabilizes while inflation remains contained and the Fed is able to keep cutting rates, the market would likely react well. For this reason, the employment reports will be particularly important going forward.
Predicting the labor market or the economy is a difficult way for investors to make money consistently. Remember in October of 2022 a Bloomberg Economics model showed a 100% chance of recession in the next year. That recession has not materialized, and the S&P 500 is up over 50% since. We will not attempt to predict future economic data points. Rather, our process relies on objective indicators about market health derived from market data itself.
It's also important to note that the market has been anticipating Fed rate cuts for quite some time. Market-based interest rates such as Treasury yields and CD rates have already adjusted downwards. The stock market has advanced persistently over the past 18 months due in part to anticipation of falling rates (though strong corporate earnings have been a bigger factor in our opinion). The future path for rates is also quite important. Data from the CME Group suggests that the market is expecting the Fed to lower rates by a total of 2% by next September. Changes in expectations for cuts into 2025 will affect the market more than the Fed decision at the upcoming meeting.
Putting all the above together, we don’t think Fed rate cuts are a reason to be positive on US stocks. Our indicators are positive on the stock market because of the strong corporate earnings picture, broad participation among companies in the market, and healthy credit outlook. In the shorter term, it would not surprise us to see minor dip in the coming months. The straight-line rally from the early August lows has been unusual; oftentimes the market revisits the lows after such swift declines. But any pullback should be viewed in the context of an ongoing bull market.
