Wall Street welcomes rate cuts but ignores the risks
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Investors are celebrating interest rate cuts that have yet to happen following Federal Reserve chair Jerome Powell's Jackson Hole speech, which opens the door to a September rate reduction.
Why it matters: Wall Street may be ignoring risks associated with a quarter-point rate cut next month that could stick around to haunt investors later on.
What they're saying: There's not going to be a swift return to the near-zero interest rate environment of recent years, Savita Subramanian, head of U.S. equity and quantitative strategy at Bank of America, tells Axios.
- The central bank's neutral rate will look more like that of the 1980s and 1990s. The market may need to "recalibrate everything to acknowledge that rates are likely to remain at higher levels," she says.
- The market is not priced for that right now, she adds.
Reality check: "The Fed is risking a policy mistake," the Bank of America macro team wrote in a note after the speech.
- There are signs that the economy is accelerating, the note said, meaning that current labor market weakness could rebound. Simultaneously, the inflation picture "has not improved since the Fed started cutting last year."
- This could result in the central bank reducing rates prematurely, or reducing rates, but then having to pause before lowering them again.
Zoom in: While Powell opened the door to rate cuts, it's not guaranteed.
- The Fed is still data dependent, and will cut only if the data warrants lower rates. If it cuts too soon, it could end up pausing rate cuts again.
Zoom out: This comes as the market is already "priced to perfection" writes Paul Stanley, chief investment officer at Granite Bay Wealth Management.
Yes, but: Several corners of the market that have been left for dead are seeing a revival, which could help fuel market breadth.
What we're watching: The August jobs report on Sept. 5 and inflation data, which could make or break the cycle of rate cuts.
- After Jackson Hole, the bar is higher for data that may derail rate cuts. It's especially true with investors pricing in two quarter-point cuts this year.
