(Bloomberg) -- The size of the Federal Reserve’s highly anticipated interest-rate cut this week is less relevant for equities than the health of the US economy, according to top Wall Street strategists.
The Fed is expected to ease policy on Wednesday for the first time in four years as investor bets suggest a coin-toss between a 25 basis-point cut or a larger 50 basis-point reduction. Expectations of easing and a so-far robust economy have driven gains of more than 30% in the S&P 500 since November, with investors now assessing whether the US can avoid a recession after years of high rates.
“If the labor data weaken from here, markets can trade with a risk-off tone regardless of whether the Fed’s first move is 25 or 50 basis points,” Morgan Stanley’s Mike Wilson — among the most notable bears until mid-2024 — wrote in a note. On the other hand, if jobs were to strengthen, a series of 25 basis-point reductions into mid-2025 could prop up equity valuations further, he said.
Forecasters at Goldman Sachs Group Inc. and JPMorgan Chase & Co. also warned that rates alone were less important for stocks, given the uncertain outlook for the economy.
“While some investors believe the speed of Fed cuts will be the key determinant of equity returns in coming months, the trajectory of growth is ultimately the most important driver for stocks,” Goldman strategist David Kostin wrote in a note dated Sept. 13.
Stocks have seen a higher degree of volatility over the past two months on an uncertain economic outlook. US elections are looming as an additional risk in the near term.
Furthermore, signs that the economy is slowing would weigh on the lofty expectations for profit growth over the coming quarters. More analysts were already downgrading than upgrading profit forecasts over the past few weeks, according to a Citigroup Inc. index.
Historical Signals
JPMorgan’s strategy team including Mislav Matejka has looked at the S&P 500’s historical reaction to Fed rate cuts for clues.
In the past, stocks’ initial reaction to the start of policy easing had been muted, and “the subsequent performance diverged a lot, depending on which growth outcome prevailed,” the strategist said.
Rate cuts into a recession “unsurprisingly” led the benchmark index lower over the year, while resilient growth fueled “high-teen” returns, he said. One point of contrast, Matejka warned, was that the gauge only advanced an average of about 4% in the 12-months before policy easing started in previous cycles.
At Goldman Sachs, Kostin said a historical analysis was probably unreliable in the current circumstances given the magnitude of policy easing already priced in by the market. Swap traders are expecting more than 200 basis points of easing by May.
“If the market prices less Fed easing because the economy proves resilient, equities will rise despite higher bond yields,” Kostin said. “In contrast, if the market prices additional Fed easing because economic data worsen, equities will struggle even as bond yields decline.”
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