Bull Market Celebrates Second Anniversary: Will Fed Rate Cuts Impact Stock Investors?
The bull market in U.S. stocks marked its two-year anniversary this past Saturday, with the Dow Jones Industrial Average and the S&P 500 index reaching new record highs as the week concluded. Despite rising concerns regarding inflation and the uncertainty surrounding the Federal Reserve’s future interest rate cuts, many analysts believe that the stock market has the potential to continue its upward trajectory.
Remarkable Gains Since the Bear Market
The S&P 500 has registered an impressive climb of over 60% since October 12, 2022, when the index recorded a bear-market low closing price of 3,577.03, according to Dow Jones Market Data. This remarkable growth has outpaced expectations, prompting several Wall Street firms to raise their year-end price targets for the index multiple times this year. For instance, Goldman Sachs recently adjusted its S&P 500 target for the third time in 2023.
Inflation Concerns and Interest Rate Expectations
Recent economic data has fueled concerns about inflation, which could complicate the Federal Reserve’s approach to interest rate cuts. The consumer price index (CPI) for September, published earlier this week, showed a 0.2% increase—slightly above forecasts of a 0.1% rise. The core CPI, excluding food and energy, rose by 0.3% as opposed to the anticipated 0.2% gain. Despite this, the producer index data released subsequently indicated that inflation levels are relatively low and stable, allowing the stock market to react moderately to the CPI release.
José Torres, a senior economist at Interactive Brokers, indicated that October’s inflation data may be even more surprising than September’s numbers, particularly due to factors such as the recent escalation in Middle Eastern oil prices and the impact of the Boeing strike. However, this upcoming CPI report won’t be available until November 13, following the Fed’s policy meeting on November 7.
Current Federal Reserve Rates and Outlook
As it stands, futures markets indicate an 87.9% likelihood that the Fed will implement a 25 basis point rate cut in November, a decline from the 97.4% expectation just a week prior. However, analysts suggest that inflation expectations could be a more pressing issue than inflation itself. Macquarie strategists Thierry Wizman and Gareth Berry noted a rising trend in five-year breakevens—an important indicator of inflation expectations—that approached 2.3% last week after being significantly lower in August and mid-September.
While the rise remains consistent with the Federal Reserve’s 2% inflation target using the personal consumption expenditure index, the strategists expressed concerns that a spike towards 2.5% could lead the Fed to reconsider its rate-cutting strategy. JoAnne Bianco, a partner at BondBloxx Investment Management, echoed sentiments that rates may not drop as low as previously anticipated, suggesting that a rate closer to 3% makes more sense.
The Market’s Resilience Amid Uncertainty
Despite worries over the rate path, analysts like Damian McIntyre, a portfolio manager at Federated Hermes, propose that the ultimate federal funds rate could end up around 3.5% or even 4% if inflation persists. Still, they underscore that a more moderate rate trajectory may not necessarily preclude stock market gains. Torres noted, “If the Fed accepts higher inflation… then that’s great for stocks, because stocks are priced nominally.” This implies that profits may rise with inflation, providing a boost to stock valuations.
The Risk of Recession is Mitigated
The primary concern for equity markets resides not in inflation but rather the possibility of a recession. With the Fed already having lowered its policy rate by 50 basis points in September, there appears to be a reluctance to allow unemployment to escalate significantly, according to Thomas Urano, co-chief investment officer at Sage Advisory. This dovish stance from the Fed could reduce recessionary fears, indicating potential market stability in the coming months.
As the bull market enters its third year, analysts remain optimistic about sustained stock performance. With a favorable seasonal outlook for November and December, coupled with a dovish Fed, it seems challenging to find scenarios where the equity market would undergo a prolonged correction in the near term.
Conclusion
In conclusion, while inflation and interest rate dynamics will continue to be focal points for investors, the resilience demonstrated by U.S. stocks over the past two years, coupled with a supportive Federal Reserve policy, indicates that stock investors might weather any rate adjustments without significant disruptions. As the market continues to evolve, investors will need to keep a close eye on upcoming economic data and central bank decisions to navigate these changes successfully.