The market is encouraged by the possibility of the Federal Reserve starting to significantly lower interest rates next year, but Wall Street experts warn that rate cuts are a double-edged sword as they will have an impact on the overall economy.
As inflation continues to cool, the Federal Reserve has also held down the 'pause button' and investors have raised their expectations for a rate cut in 2024. The CME Federal Reserve observation tool shows that the market currently expects a high probability of a rate cut by the Federal Reserve as early as May next year, as high as 85%. The lower than expected inflation report released last week further fueled this optimism.
Paul McCulley, former chief economist at PIMCO, said, "I think this will change the game rules because the data clearly shows what we have been waiting for. I think this leads the Federal Reserve to now confidently declare that policy is already restrictive enough, which is a big deal because it means they have ended tightening and the next step will be relaxation
However, rate cuts may not be the obvious bullish catalyst that the market hopes for. This is because any easing policy by the Federal Reserve may be a response to an economic slowdown, and a truly significant interest rate cut may be the result of a comprehensive economic recession.
In fact, the market has been paying attention to the Federal Reserve's interest rate cut to trigger a bullish rebound in the stock market. But economic recession is usually a strong headwind for the stock market. Last month, the chief market strategist at JPMorgan estimated that if there were an economic downturn, the stock market could plummet by up to 20%.
Chris Grisanti, Chief Equity Strategist at Mai Capital Management, an asset management company, said, "For stock investors, the reason for the bottom in stock prices is heartbreaking... that the economy is slowing down, and I believe this will show up in the next three to six months
Deutsche Bank strategists say that out of the past 10 economic downturns, the Federal Reserve has cut interest rates five times before the recession. This indicates that interest rate cuts will not automatically prevent an economic downturn, and are often signs of impending problems, "the bank wrote in a report
According to UBS, as the economy enters a recession in the middle of next year, interest rates may eventually decrease by 275 basis points. This is approximately four times the expected rate reduction in the market, which means that the economy may slow to a level where the Federal Reserve believes it is necessary to withdraw the significant monetary tightening policies implemented since March 2022.
UBS strategists warned in a report that the rate cut would be a "response to the forecast of an economic recession in the United States from the second quarter to the third quarter of 2024, as well as a sustained slowdown in overall and core inflation".
Signs of slowing down have emerged
Signs of economic slowdown have emerged in some economic sectors. Economists at the Federal Reserve Bank of Atlanta predict that the real GDP growth rate will reach around 2.2% this quarter. Compared to the 4.9% growth announced in the previous quarter, this is a dramatic slowdown.
According to data from the US Census Bureau, retail spending also decreased by 0.1% last month. This is the first time retail spending has fallen since March this year, and it is a sign that American consumers, who have helped support the economy this year, may finally begin to lose momentum as their savings have decreased.
The cooling of the labor market has exacerbated the decline in spending. The United States added 150000 new jobs in October, a significant decrease compared to September, and the unemployment rate rose to 3.9%.
These employment data indicate that the job market is approaching triggering the "Sahm Rule". Sam's Law is a highly accurate indicator of recession. When the average three-month unemployment rate is 0.5 percentage points or more higher than the low point of the past 12 months, it indicates that the United States has entered the early stage of economic recession.
Former Federal Reserve economist and creator of the Sam's Law, Claudia Sahm, said in an interview, "We are not in a recession, but we are getting closer to the red light on economic indicators and cannot guarantee that we will not fall into a recession in the future