Rate cuts are going to send shares higher and bond yields lower, right? A win-win for portfolios. Not so fast, as the effect a Fed cut will likely have on portfolios could be anything but predictable. The truth is that monetary easing is not the economic steroid it once was, and investors know it, so the odds of a pop in the market seem low. This is doubly true because much of the possible gain from rate cuts has already been priced in by the market due to how well the Fed has telegraphed this move. If any stocks should do well, it would be small caps, which are more reliant on borrowing and thus would gain the most from lower rates.
FINSUM: This cut has been so anticipated that it will likely be greeted by a shrug. If anything, we think there are more downside risks.
The broad expectation is that rate cuts will boost all bonds. To some degree this is likely true. However, not all bonds will be affected to the same degree. For instance, safe bonds—think investment grade corporates and Treasuries—have likely already seen most of the gains they will. But high yields are a different story, as they are much more likely to see a decent rally, as lower borrowing costs are a bigger boon to those companies and the cuts themselves will help sustain the economic cycle, which is more important for them than for ultra-safe companies.
FINSUM: This seems to be pretty good analysis. This rate cut has been widely projected and safe bonds have already seen gains, so junk may be the biggest beneficiary.
UBS just went on the record warning of a potential bursting bubble in equity markets. The bank’s CEO says that global coordinated central bank easing posed a threat to markets and risked inflating a bubble. “I’d be very, very careful about growing further the balance sheet of central banks”, said CEO Sergio Ermotti. He further explained that current market prices were out of sync with investor sentiment, posing a risk. However, he did say that clients were ready to buy the dips in the market, which was an encouraging sign.
FINSUM: The equity markets remind us a bit of US politics at the moment. There are a lot of people in the middle without a lot of conviction, but those on the sharper ends are driving the whole thing forward.
Most investors spend their time worrying the Fed is going to cut the party short. Historically speaking, that has often been the role of the central bank—keeping things from getting too out of hand. However, Fed chief Powell does not appear to want to be the sober chaperone at the party this year, as the dovish positioning is heavy. Accordingly, there seems to be a strong chance of a melt up in stocks right now, or a big late stage rally. UBS, however, says the opposite, arguing that investors will stay hesitant because of high valuations and weak earnings.
FINSUM: We don’t think there will be a melt up. We just think the market will re-enter the post-Crisis goldilocks mode they were in, where rates are low and the economy is healthy, clearing the way for multiple expansion.
The Fed has historically been the level-headed kid at the party, always trying to calm things down when they got out of hand. But that appears to no longer be the case, as Powell surprised even the most dovish investors with his very soft statements last week. What comes next may shock markets—some think the Fed will make a rare 50 bp cut in their July meeting. How the market would react is anyone’s guess (likely positive initially). “Historically the Fed has wanted shock and awe when they ease”, says the CIO of Northwestern Mutual Wealth Management.
FINSUM: The Fed seems like it wants to go big, despite the fact that unemployment is at record low levels and prices are stable. The central bank clearly wants to keep the bull market rolling.