The focus on anticipating rate cuts has been prominent in 2024. However, with a series of robust economic indicators presenting challenges for the Federal Reserve, there is growing speculation in the markets: What if the Fed decides against cutting rates this year?
Fed Chair Jerome Powell has consistently emphasized the need for “more confidence”, reiterating the central bank’s commitment to bringing inflation closer to the 2% target. A notable 3.3% spike in fourth-quarter GDP, the addition of 353,000 new jobs in January, and inflation at 3.1% are all data points complicating Fed policy, causing concern among markets eagerly anticipating a decline in interest rates.
The recent weeks of strong economic data have prompted some in the market to raise questions about the potential impact if Powell and the Federal Reserve choose not to implement rate cuts this year or, at the very least, maintain rates at a level higher than what markets are anticipating.
Stocks are predicted to remain robust, while bonds may face challenges
Analysts from Bank of America stated in a recent note that S&P 500 stocks are expected to be well-positioned, regardless of future Federal Reserve actions. The note emphasized that strong returns for the year were anticipated due to the accomplishments of the Fed from March 2022 to the present, rather than future actions in 2024.
Echoing this sentiment, other market experts suggested that although a scenario without rate cuts is not the most likely, the business cycle should support ongoing stock gains regardless of policy decisions.
David Rosenberg, economist and founder of Rosenberg Research, noted that in such an environment, healthcare and consumer staples are likely to outperform. He used the analogy that in the land of the blind, the one-eyed man is king.
However, the outlook for bonds, particularly longer-term treasury bond yields, is less optimistic. Rosenberg highlighted a 90% correlation between expectations for monetary policy and longer-term treasury bond yields, suggesting that the 10-year Treasury could rise to 4.7%, not significantly different from the multi-decade highs seen at the end of the previous year.
Continued increases in interest rates present potential downsides for bank stocks, as noted by analysts from Bank of America in a separate communication.
Investor concerns revolve around banks holding numerous lower-yielding bonds. In a high-interest rate environment, these bonds, offering minimal returns, may not effectively offset the banks’ higher funding costs, resulting in a “negative carry” risk, according to the analysts.
While a stronger economy indicates improved credit quality and growth, there is apprehension among investors regarding an extended period of tight monetary policy, marked by higher rates and quantitative tightening (QT), due to perceived liquidity-related risks, as mentioned by BofA analysts.
David Rosenberg echoed these concerns about potential risks for banks. He highlighted that if the Fed refrains from rate cuts due to inflation concerns rather than economic factors, it could have decisively negative implications for bank stocks.
The real estate sector is set to endure further challenges
The commercial real estate sector has been significantly impacted by the Federal Reserve’s rate-hike campaign, and any delay in rate cuts would prolong the challenges in that industry.
Commercial property owners are facing a wave of debt maturities in the current year and beyond, requiring many landlords to refinance debt at higher rates and cope with lower property valuations. The office sector, especially affected by ongoing remote work and declining property values, is in a precarious state. Last month, real estate billionaire Barry Sternlicht warned of potential losses of up to $1 trillion in the office market.
Bank of America suggests that extended higher rates could heighten concerns about credit risks related to the repricing of commercial real estate loans. Elevated borrowing costs may pose obstacles for property owners in repaying their loans.
Investors have been uneasy about regional banks in the past year, with renewed concerns emerging this month, particularly regarding New York Community Bank, partly due to its exposure to commercial real estate.
In the residential sector, the failure to significantly lower rates would result in another year of sluggish markets, resembling the challenges of the previous year marked by low inventory and the lowest sales since 1995.
“The real estate market would be undercut by the Fed’s failure to cut interest rates,” remarked Rosenberg.
Investors may be wondering about the conditions under which the central bank is unlikely to adjust interest rates this year.
According to Deutsche Bank analysts, if inflation remains at 2.7% or higher, coupled with an unemployment rate of 4% or lower, the Fed is likely to maintain a hawkish stance.
Recent data has aligned with such a scenario, with consumer inflation in January reaching 3.1%, surpassing expectations. The latest nonfarm payroll report also revealed a remarkable addition of 353,000 jobs last month.
Despite these indicators, economist David Rosenberg does not anticipate the US economy overheating in 2024. He emphasizes the need for a realistic perspective, stating that there is no basis for expecting economic acceleration this year compared to the previous year.
Rosenberg acknowledges that markets can withstand high rates when the economy is growing, but he warns that additional rate hikes aimed at curbing inflation could be more disruptive.
According to Business Insider.
By. Pham Thanh Bien
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