J.P. Morgan global chief strategist David Kelly said he expects the Federal Reserve to begin rate cuts before the year's end based on improving inflation data.
"There will be better news about inflation before year-end," Kelly said during a J.P. Morgan Asset Management webinar yesterday. “The Fed continues to be confident that the economy is in the right place.”
Inflation in March, as measured by the personal consumption expenditures (PCE) price index, which measures the change in prices for goods and services consumed, came in at an annual rate of 2.7%, above the Fed’s 2% goal but well below inflation’s 7.1% high mark back in 2022.
“We are not that far” from the Fed’s target, he said. “They just want to take their time."
Indeed, hours before the webinar, Fed Chair Jerome Powell said he was “prepared” to cut rates when inflation cooled further and that current monetary policy was sufficient to bring inflation down to the 2% target. Powell added that he doesn't expect the Fed to raise rates in its June meeting.
“I think the Fed has done a pretty good job of not overreacting to inflation,” Kelly said.
He said that stagflation and recession seem “very far from being on the table right now.” He pointed out that the consumer price index (CPI), which measures the change in the out-of-pocket expenditures for households, showed an inflation rate for the 12 months ending March of 3.5%, while unemployment came in at 3.8%.
Together, they add up to a “misery index” of 7.3%, which he said is actually lower than it's been 75% of the time over the past 60 years.
“The economy is running a little hotter than the Federal Reserve would like, or financial markets had expected,” Kelly acknowledged. “[But] it seems to be on track.”
He cited strong job growth and rising labor-force participation with “not much danger” of a decrease. “This is a healthy economy,” he said. “We’re not showing signs of overheating any more than we’re showing signs of [slowing down] into recession.”
He said that progress on inflation has “stalled out a little for now.” But the data shows that year-over-year growth in consumer prices for goods alone is close to zero, he said. What’s driving inflation is the services side of the economy, he said, especially prices for auto insurance and rent.
Though he urged patience for rate cuts, Kelly dismissed fears that the Fed might actually raise rates this year.
The Fed “genuinely believes that inflation is trending in the right direction,” he said, adding that inflation is already near 3%, not far from the central bank’s target. If the Fed raised rates now, he said, it would look like it had made a mistake when it lowered them last year. “They never like to admit they made a mistake,” he said, “because that would undermine their credibility.”
David Lebovitz, J.P. Morgan Asset Management’s global strategist for multi-asset solutions, spoke next about the market outlook from an asset-allocation perspective.
“We are leaning into risk,” he said, adding that “global growth and particularly U.S. growth have proven to be quite resilient. That growth is beginning to broaden out to Southeast Asia and across Europe.”
Specifically, he is cautiously bullish about equities. “Earnings are going to be the key driver of returns,” he said.
In the current earnings season, with more than half of U.S. companies already reporting, he noted that 71% of them are beating their earnings estimates and 53% are beating their revenue estimates. “The earnings growth we are seeing is very healthy,” he said. “We think that overall earnings growth is going to remain decent.”
On bonds, he said yields are positive and valuations “don’t look bad.” Uncertainty about Fed tightening has caused interest-rate volatility, he said, which is why he is neutral on duration—meaning he favors neither long-term nor short-term U.S. debt.
He prefers European debt instruments over their U.S. counterparts, largely because he expects the European Central Bank to lower interest rates and ease the Eurozone economy well before the U.S. does.
When it comes to emerging markets debt, he prefers dollar-denominated notes. He does not see a catalyst for local EM currencies to move higher against the dollar.
He is neutral on the dollar until the U.S. economy and Fed policies become clearer.
Corporate bonds are “a little more complicated,” he said. The fundamentals look robust, he said, but the valuations are “subject to interpretation.”
Nevertheless, since the outlook for earnings remains “very solid,” he said that he feels confident corporate credits can “perform well going forward. … We like the idea of owning credit.”