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Investors question the apparent paradox presented by the combination of securities traded at record levels or close to record and a Federal Reserve that seems ready to apply an imminent rate reduction.
Lily: An economy that has become "crazy"? Fed to lower rates despite record stock prices and low unemployment
A glance at history shows that the Fed has been willing to cut rates with headlines reaching unprecedented highs in the past, but this has not been seen in more than 20 years. Charlie Bilello, a market analyst, said last week on Twitter that since the Fed started targeting the fed-fund rate in 1982, it has been getting rate cuts with the S & P 500
SPX, + 0.02%
record seven times higher – the last such decline occurred in January 1996.
Futures on federal funds show that traders see a 100% chance of reducing rates when policymakers meet July 30-31. Meanwhile, the S & P 500, the Dow Jones Industrial Average
DJIA, + 0.10%
and the Nasdaq compound
COMP + 0.17%
On Monday, Fed Chairman Jerome Powell said on Monday that his president, the highest all-time record, broke record breaking records.
See: Powell's testimony leaves Fed observers scratching their heads
Ryan Detrick, senior market strategist at LPL Financial, which has advisory and brokerage assets of about $ 684 billion, found that the Fed had cut rates 17 times since 1980, the year in which S & P 500 index was less than 2% of its highest historical level. He also observed that the Fed was stronger one year later, all 17 times, with a median gain of 10.4%.
The first "insurance" cut?
Of course, as the old saying goes, the stock market is not the economy. As expected by Bilello, a drop in rates at the Fed's July 30-31 meeting – as is widely expected – would mark the first time the central bank lowers its rates, with an unemployment rate of 3.7 % in June, less than 4%.
Thus, if the Fed follows up on excessive expectations, it could mark what Jeffrey Schulze, investment strategist at ClearBridge Investments, who manages an asset of about $ 142 billion, would be the first real "blueprint". insurance "cut by the makers.
Read also: Should investors prepare for a shock and fear campaign from the Fed?
While a number of investors and analysts have described easing in 1995 and 1998, when rate cuts were not followed by recessions, while the movements of 39, insurance have evolved, Schulze noted that in these cases, the Fed had reacted after the fall of the manufacturing indicator of the Institute for Supply Management to less than 50, indicating a contraction of l & # 39; activity.
"If the Fed actually does the reduction in July this year, I think it will be the first reduction in insurance, if you like," Schulze said in an interview.
The ISM manufacturing index is under pressure and dropped to 51.7% in June. This is the slowest pace of expansion in the sector for over two years. Powell cited the decline in the indicator as he pointed to worries over the economic outlook in his testimony before Congress last week.
The motivations
Some market watchers have linked the Fed's aggressive leaning to President Donald Trump's constant criticism of the central bank and Powell. Trump argued that past Fed rate hikes had put the US economy at a disadvantage and said policymakers should lower rates and resume quantitative easing.
Rex Nutting: Trump and the stock market fear Powell to make this rookie mistake
Others have claimed that the central bank inspired financial markets.
"While growth has yet to deteriorate significantly – again, we expect to be about to achieve a 4% footprint of real consumption growth for the second quarter – we are no longer talking about the future." 39; a soft landing approach here, but rather a higher potential economic backing, "said Tom Porcelli, chief US economist at RBC Capital Markets, in a note.
"In addition, a one-quarter point or two cut in the federal funds rate has a potential low cost and the benefit of the easing of financial markets," he said.
"Maybe the reaction function is as simple as that. In an economy that remains characterized by strong household balance sheets, continued deleveraging, high savings, high confidence and rising wages, the risk of an unsustainable debt-fueled bubble seems quite low, "he said. said Porcelli.
Test time
Schulze, meanwhile, argued that the Fed was right to pay attention to fears of a slowdown. ClearBridge's internal recession indicator went from green to yellow, indicating a 50% recession probability. While markets tend to rise immediately after reading in yellow, he sees a "high probability" of a 5% decline in equities over the next three months.
For now, however, the reaction of the stock market to the Fed's transition is not surprising. "Whether you're going into a recession or one of those false positives, like what you've seen in" 95 "or" 98, "the rate cuts are still being rewarded by the market," he said. Schulze. "It's the initial euphoric reaction, and I think you see it today."
A major test could come in the third or fourth quarter, he said. Continued deterioration in global macroeconomic data and a weakening of US equities would likely make investors more alarmed by the threat of a recession, which could lead to another 5% to 10% decline.
Related: Why is Citi's chief equity analyst worried about a "soft patch" in the second half of the month?
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