Equity Bulls Bet on Soft Landing as Fed Rate Cut Expectations Rise

by webmaster

Equity bulls predicting a smooth landing for the economy find solace in the market-based expectations for the Federal Reserve to reduce its key lending rate by approximately 1.5 percentage points in 2024^1^. According to historical data, the Fed has typically delivered interest rate cuts of 1.5 percentage points, equivalent to 150 basis points, within a year, but this was often in response to a recession^1^.

Stocks experienced a strong rally and achieved several record highs towards the end of last year. The Dow Jones Industrial Average (DJIA) had notable closings, while the S&P 500 (SPX) witnessed a total return of over 26% and came close to its Jan. 3, 2022, record finish by a mere 0.5%^1^. However, stocks have retraced slightly at the start of the new year.

The rally in 2023 accelerated as investors adjusted their expectations to incorporate a potential change in Fed policy towards lower interest rates. Although rates traders have lowered their projections for cuts in 2024, fed-funds futures still indicate a 53.8% probability of a decrease of at least 150 basis points by December, as per the CME FedWatch tool^1^.

As depicted in the chart above, there was an exceptional scenario in the 1980s when Paul Volcker led the Fed. However, it was an outcome of the Fed raising rates to a “super-restrictive” level, making it incomparable to the current situation^1^. Another exception occurred in the late 1960s during the Vietnam War when there was a significant increase in public spending that led to subsequent inflation, now viewed as a policy error^1^. Furthermore, the Fed aims to avoid a similar outcome, emphasizing a desire to prevent an increase in inflation^1^.

Therefore, the historical precedent suggests that the current expectation of rate cuts is more closely associated with a recession rather than a smooth landing. If a recession does not occur, accomplishing a 150-basis point reduction over 12 months becomes highly challenging^1^.

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