The Fed probably won't cut rates anytime soon. Why that's good news for markets

The Federal Reserve is expected to soon pause its aggressive rate-hiking cycle, which has battered markets and tested investor morale. However, cuts to interest rates may be farther off than some believe.

The Fed probably won't cut rates anytime soon. Why that's good news for markets

New York CNN

Wall Street wants to see the Federal Reserve end its aggressive cycle of rate hikes that has battered markets, and tested investor confidence. While a pause on interest rate increases appears to be imminent, the cuts could be further away than many believe.

Stocks have remained resilient after a turbulent 2022, which was marked by inflation, interest rate increases from the Federal Reserve, Covid closures and geopolitical tensions.

Investors have been on high alert for any signs that the central banks' rapid rate hikes could slow down. In May, the Fed raised rates by a quarter-point for its tenth consecutive hike. The central bank has also left the door open to a pause. This is accelerating the bets on the Fed holding rates at their next meeting in June, and cutting rates as early as July.

Experts say the Fed is unlikely to cut rates anytime soon - at least not if the US economy remains strong. (All bets are out if US defaults on debt). They say that a pause in rate hikes could be better for the stock market than a reduction.

The Fed is unlikely cut rates in July

Experts believe that the Fed will not cut rates any time soon because of two main reasons: inflation remains high and the economy is strong.

Despite stabilizing prices, inflation is still well above the Fed’s 2% inflation target. The Fed's preferred measure of inflation, the Personal Consumption Expenditures Price Index, increased by 4.2% in the 12-month period ending March.

The unemployment rate in the United States is also at an all-time low. US housing prices are rising in certain parts of the US despite a cooling market.

There's also nothing, at least not yet, that convinces the Fed to pivot towards lowering interest rates.

Kara Murphy, Chief Investment Officer at Kestra Investment Management, said that the Fed cuts rates rarely without a crisis between.

Fed rates were last cut after an emergency meeting held in March 2020. The Covid-19 pandemic had sent US stocks into their first bear market since 11 years, and sparked fears that the global economy might tip into recession.

In the wake of this year's collapses by Silicon Valley Bank Signature Bank and First Republic Bank, there were fears that credit standards would tighten and banking could be in turmoil. The turmoil is largely confined to regional banks and financial and economic leaders maintain that the banking industry remains stable.

Liz Ann Sonders is the chief investment strategist for Charles Schwab. She says that the central bank would need to see a serious decline in the banking industry, a collapse in the labor market, or an economic nosedive of similar magnitude before it could lower rates.

Sonders said that 'the Fed would lose whatever credibility it has left if they suddenly went from raising to cutting'.

A July stock market cut would be beneficial?

A bull market is not guaranteed even if the Fed lowers rates soon.

Credit Suisse reported in a note dated May 9 that historically, stocks have performed tepidly after a pivot towards rate cuts as opposed to a pause. The S&P 500 has historically risen 16.9% in average over the past 12 months in response to the Fed's last rate hike and dropped 1% the following 12 months.

Assuming the rate hike on May 3 was the final one of this cycle, the stock market should do well for the rest of the year. Analysts said that if the Fed eased in July, as implied by the futures, the upside would be much more limited.

Cut rates too early and the consequences could be severe for the economy.

Arthur Burns, the then-chairman of the Federal Reserve Board (Fed), dramatically increased interest rates between 1972 and 1974. He then cut them as the economy contracted.

Paul Volcker, who led the Fed at that time, took dramatic action when inflation soared. The Fed raised interest rates to try to control it. Fed funds rates were at their highest in July 1981. The Fed's aggressive tightening led to two consecutive recessions with unemployment rates as high as 10 percent.

Powell acknowledged these mistakes in a speech he gave last August in Jackson Hole. Since then, the Fed has signaled it is unlikely to lower rates in this year. It also reaffirmed their commitment to fighting inflation.

Marco Pirondini is the US head of equity at Amundi.

Nicole Webb is the senior vice president of Wealth Enhancement Group. She says that a Fed interest rate cut in this year's budget is not impossible. She says that the Fed will eventually want to reduce rates, but not at the same pace as it has done in the past.

Webb stated that they could slowly bring us down to 2.5%, without the inflation monster resurfacing. "I do believe that it is possible."