Stocks rallied last week amid an uptick in volatility as investors digested fresh economic data that pointed to a mixed economic picture before Fed Chair Powell stated that “the time has come” to begin cutting interest rates. The S&P 500 gained 1.45% on the week.
What Powell and Ueda’s Friday Comments Mean for Markets
Friday was a very good day for investors (at least near term). I say that, because Fed Chair Powell and Bank of Japan Governor Ueda provided the market with bullish commentary that legitimately powered stocks higher. First, Ueda told the Japanese Parliament that while rates were going to trend higher over time, he’d consider market reaction to rate hikes in setting policy. Put in plain English, that means that if rate hikes cause Japanese (and global stocks) to drop, they’ll backtrack. Longer term, that may not be the best idea, but in the shorter term it significantly removes the possibility of a disorderly unwind of the yen carry trade (like we saw a whiff of in early August) and that removes market risk.
Second, Powell was more dovish than expected because he 1) Promised rate cuts in September and 2) Left the door open to a 50-bps cut in September or aggressive cuts afterwards via his stating the Fed would not “welcome” any further increases in the unemployment rate. Short of Powell promising 50 bps or actually cutting rates, this was the next best thing.
Bottom line, Ueda and Powell largely negated two of the reasons for the August pullback (yen/carry unwind and concerns about the Fed not cutting fast enough) and that’s a near term positive and makes the path higher for stocks easier. Additionally, it favors cyclical sectors including small caps, value over growth, industrials, discretionary, financials and other sectors more sensitive to economic growth.
What Risks Are Left for Investors?
Given last week’s events, there are two primary risks that could undermine this rally (and cause something larger than the pullback we saw in August). The first, and by far largest, is that growth slows more than expected. Lost in the excitement of Powell promising rate cuts was the sudden urgency behind his promise, i.e. the Fed is getting worried about the labor market. Investors, however, are not. That’s a source of potentially significant risk because if the labor market is weaker than expected or growth metrics show a bigger than expected slowdown, then stocks will drop and the looming Fed rate cuts won’t be able to stop it.
The second, less significant, risk is for disappointment from Fed rate cuts. Investors have priced in 100% probability of 75 basis points of cuts in 2024 and 65% probability of 100 basis points of cuts. Meanwhile, inflation has fallen but still sits far above the Fed’s 2% target (Core PCE Price Index is expected to be 2.6% on Friday). If the Fed cuts more gradually than expected, it will likely cause short- term disappointment, especially if data is lackluster (it’ll increase fears the Fed is “behind the curve”).
Bottom line, the near-term outlook for stocks did im- prove last week courtesy of Ueda and Powell and new highs shouldn’t be a shock. But don’t confuse that with the removal of still significant risks lingering in the distance. This bull market is, in reality, more precarious than the price action implies.
We will continue to monitor the risks and adjust portfolios accordingly when needed. The election is coming soon and could affect the markets in a positive or negative way near term. Economic growth and corporate profitability is key to further market upside. Who becomes president can help or hurt that possibility.
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