Whether the Federal Reserve can prevent a recession in time could be the deciding factor.
A Fed interest-rate cut this Wednesday is nearly certain, but how the stock market will respond to the loosening of monetary policy remains unclear.
History offers some clues: why the Fed is cutting rates matters more for markets than the fact that borrowing costs are dropping.
Vickie Chang, a macro strategist at Goldman Sachs, shared data showing that since the mid-1980s, the Fed has eased monetary policy 10 times.
Four of these rate-cutting cycles coincided with recessions; six did not. When the Fed successfully avoided a recession, stocks typically rallied. When it failed, stocks generally fell.
Investors likely won’t have all the answers on Wednesday. Market reactions will depend on data in the coming months.
“The key question for markets is whether this rate-cutting cycle will result in a ‘growth scare’ or a ‘recessionary’ episode,” Chang stated.
Historically, recession-linked rate cuts have led to a 10% drop in the S&P 500 within the first six months.
So, what might Wednesday’s cut reveal about the economy?
The size of the cut could significantly influence investor sentiment and set the market’s tone for the rest of the year.
Investors are especially eager for more clarity, partly due to the mixed signals from recent U.S. economic data. Labor reports show hiring has slowed, but more people have entered the workforce. Meanwhile, layoffs remain low, inflation has eased, but stubborn price increases in areas like rent and housing persist.
Despite optimism earlier in 2024 that helped stocks rise, investor confidence has recently wavered. Concerns about rising unemployment have contributed to significant selloffs in August and September.
Has the Fed already fallen behind?
Some believe the Fed missed the opportunity to cut rates in July, which could lead to a negative market reaction if Wednesday brings a larger-than-expected 50 basis point cut. Wall Street views such a move as a sign that the Fed might have fallen behind the curve or that worse economic data is yet to come.
Shannon Saccocia, CIO at Neuberger Berman Private Wealth, said, “A 50 [basis point cut] would suggest the Fed made a mistake in July, or that they have more worrying data than what’s publicly available.”
This uncertainty could trigger an initial market selloff regardless of what the Fed decides, according to Deutsche Bank strategists. They noted that the Fed could surprise the market by the widest margin in 15 years, regardless of the cut’s size.
In addition to the rate decision, the Fed’s latest economic projections will be closely examined.
John Velis, a macro strategist at BNY Mellon, expects the Fed to raise its unemployment forecast while lowering its GDP growth outlook. This wouldn’t necessarily signal an impending recession, but investors should take note as it may influence how aggressively the Fed continues cutting rates.
On the verge of a historic achievement
Although no recession signals have emerged yet, investors remain cautious.
Successfully guiding the economy through inflation without triggering a recession would be an extraordinary achievement for Fed Chair Jerome Powell. KPMG U.S. economist Diane Swonk noted that pulling off such a soft landing would be unprecedented.
The Fed has successfully navigated difficult economic environments before, such as the rate cuts of 1995, which resulted in a “mid-cycle adjustment” without damaging markets, according to Jurrien Timmer, director of global macro at Fidelity.
“It’s rare, but it can happen,” Timmer told MarketWatch.
Last week, U.S. stocks finished strongly, with the S&P 500 and Nasdaq Composite marking their largest weekly gains since November 2023, according to Dow Jones Market Data. The Dow Jones Industrial Average also posted its best week in a month.
The Fed’s September policy meeting kicks off Tuesday, with the interest-rate decision set for release Wednesday at 2 p.m. Eastern Time.
