With expectations for Federal Reserve interest rate cuts increasing among investors and economists alike, some of the biggest U.S. banks are mapping out the implications for financial markets.
Strategists at JPMorgan Chase & Co. and Goldman Sachs Group Inc. are among those mining history and running models to divine the potential path for different asset classes.
Here’s what the market watchers are saying so far:
JPMorgan strategists including John Normand and Nikolaos Panigirtzoglou:
“We favor the optimistic view but conviction is not high.”
Mid-cycle easing by the Fed can renew bull markets, but cuts prior to recessions simply extend bear trends. JPMorgan’s recession-risk model suggests the upcoming Fed cycle may be a bad one for risky markets, but underlying leverage dynamics suggest that these cuts should support markets.
Bonds don’t tend to rally sustainably during mid-cycle easing because the Fed reverses those insurance cuts eventually. Recessions tend to generate bond rallies until about nine months after the first easing; that’s approximately when activity data are reviving. Equity markets appear to be pricing in a pre-emptive Fed that is set to provide insurance; if the Fed ends up being reactive, equities could follow a weak trajectory.
History shows that Treasury yields continued to rally and the curve continued to steepen for up to six months on average after the first rate cut. Credit spreads widened on average during the first six months. The dollar was on average on an upward trajectory for up to three months.
Goldman Sachs strategist David Kostin and team:
“The S&P 500 index has typically generated strong returns at the beginning of Fed cutting cycles.”
Goldman analyzed equity returns during the past 35 years following the start of seven Fed cutting cycles. The index climbed by a median of 2% and 14% during the 3- and 12-month periods following the start of a Fed cutting cycle, respectively.
If the Fed doesn’t plan to cut, it will need to walk back market expectations, and the few previous instances suggest that the S&P 500 would fall in that case. If the Fed does cut, Health Care and Consumer Staples tend to outperform and Information Technology consistently lags. Momentum and low volatility factors also outperform.