By Louis Krauskopf
(Reuters) – With interest rate cuts virtually confirmed, investors are turning more attention to economic data over the coming months to see whether the “soft landing” scenario that has boosted U.S. stocks in 2024 can continue.
Federal Reserve Chairman Jerome Powell said Friday that “the time is right” to start cutting interest rates, a more dovish message than many investors expected to hear at the Fed’s annual meeting in Jackson Hole, Wyoming. The process is expected to begin next month, with a 25-basis-point rate cut at the Fed’s monetary policy meetings on Sept. 17 and 18.
Such comments are far from a signal of total safety: With the S&P 500 up 18% this year and stock prices at expensive levels, market participants need continued evidence that the economy is headed for a soft landing, with growth remaining strong and inflation subsiding.
“What the market was looking for was a signal that a rate-cutting cycle had begun,” said Alessio de Longis, senior portfolio manager and head of investment at Invesco Solutions.
But “is the Fed actually saying it’s worried about the economy right now? If so, maybe expectations for a rate-cutting cycle should be looked at differently.”
History shows that stocks tend to perform much better when interest rates are cut against the backdrop of resilient growth rather than a sharp economic downturn. Since 1970, the S&P 500 has risen an average of 18% a year after the first interest rate cut outside of a recession, according to strategists at Evercore ISI. During recessions, the index has risen an average of just 2% a year after the first rate cut.
In his speech, Chairman Powell said the Fed “neither seeks nor welcomes” a further slowdown in the labor market and wants to prevent it from worsening further. Employment will be in the spotlight when the U.S. releases its closely watched jobs report on Sept. 6, after labor market data in early August came in weaker than expected.
Other key data due to be released include two monthly inflation reports: the Personal Consumption Expenditures Price Index on August 30th and the Consumer Price Index on September 11th.
Further signs of a weakening economy could rattle stocks again and raise hopes for a 50-basis-point cut next month. Expectations of such a cut were priced in at about 35% as of Friday afternoon, up from about 29% before the speech, according to futures data, with remaining expectations priced in for a 25-basis-point cut.
“The Fed is easing monetary policy while the economy is not particularly weak (and inflation remains above target) and could ease significantly in response to any sharp weakness,” Rick Rieder, chief investment officer of global fixed income at BlackRock, wrote in a Friday note.
Quincy Krosby, chief global strategist at LPL Financial, said a key factor for stocks is whether the rate cuts are due to easing inflation or a weakening labor market.
“Inflation is coming down, so the market is hoping for a rate-cutting cycle,” Crosby said. “The question remains as to whether we’re going to see a further deterioration in the labor market.”
The strong data could help buoy stocks at a time when some expect volatile trading. September has historically been the weakest month for stock performance, with the S&P 500 down an average of 0.78% since World War II, according to CFRA data.
Rising stock prices could also discourage investors from holding on to stocks when bad news hits: The S&P 500’s forward price-to-earnings multiple has risen to 21 times forward earnings, up from 19.6 times in early August, according to LSEG Datastream. The index’s long-term average is 15.7 times.
The tight presidential race between Vice President Kamala Harris and former President Donald Trump may also cause uncertainty between now and the Nov. 5 election.
“The long-term trends in the stock market are quite stable, and a bear market is an opportunity to increase exposure,” said Andre Bakos, managing member at Ingenium Analytics LLC. In the short term, “it’s going to be choppy and volatile because no one knows what’s going to happen now that Chairman Powell has shown his hand.”
(Reporting by Louis Krauskopf in New York; Additional reporting by Bhansali Mayur Kamdar in Bengaluru; Writing by Ila Iosebashvili; Editing by Matthew Lewis)
