Finance

Investors expect rate cuts. But what will happen to the market if interest rates are not cut this year?


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  • Hot economic data so far this year has cast a shadow on prospects for rate cuts.

  • Some market professionals have been eyeing the possibility of interest rates remaining high into 2024.

  • In this scenario, stocks could still rise, but bonds and real estate would take a hit.

Gambling on interest rate cuts has always been a major theme in 2024, but as a series of hot economic data keeps the Federal Reserve on alert, some market participants are beginning to wonder: What if the Federal Reserve does not cut interest rates this year?

“More confidence is needed” is a slogan that Fed Chairman Powell keeps repeating. He is very clear about the central bank’s goal of controlling inflation levels. Close to the 2% target.

a spike GDP grew 3.3% in the fourth quarterbig Packer into 353,000 new jobs added in Januaryand Inflation rate is 3.1% All of these data points complicate Fed policy and roil markets eagerly awaiting lower interest rates.

Strong data over the past few weeks has some in the market asking questions about what the impact might be if Powell and his colleagues don’t cut interest rates this year, or at least keep them higher than markets expect.

Stocks remain strong, but bonds suffer

Analysts at Bank of America said in a report this week that S&P 500 stocks should still be in a good position regardless of what action the Fed takes.

“We remind investors that the strong returns we expect this year are not due to actions the Fed will take in 2024, but rather due to what the Fed has accomplished from March 2022 to the present,” the report said.

Other market professionals agreed, saying that while no rate cuts were unlikely, the business cycle should support continued gains regardless of policy.

“There’s an old saying that in the land of the blind, the one-eyed man is king. So in a relative sense, the outperformers in this environment are probably the health care sector and then the consumer staples sector,” said Economist and said founder David Rosenberg. Rosenberg Research told Business Insider.

For bonds, it’s a different story with rising prices and longer periods of time.

Rosenberg said there is a 90% correlation between monetary policy expectations and long-term Treasury yields, stressing that investors could see the 10-year Treasury yield return to 4.7%, in line with the multi-decade yields seen at the end of the year. The highs are not far off. last year.

Bank of America analysts said in a separate note that continued higher interest rates also pose potential downside risks to bank stocks.

One thing that alarms investors is that banks hold many low-yield bonds, which offer lower returns that cannot offset banks’ higher funding costs in a high-rate environment, creating “negative spreads,” analysts say. risk.

“A stronger economy means healthier credit quality and better growth. However, given the ‘perceived’ liquidity-related risks, we think investors are wary of longer-term tighter monetary policy (the longer interest rates, the higher QT) concerns,” Bank of America analysts said in a note. notes.

Rosenberg echoed the potential risks facing banks.

“if [the Fed] Rosenberg added: “Whether the Fed cuts interest rates because it is still worried about inflation rather than the economy will have a decisive negative impact on bank stocks.”

Real estate faces more pain

Commercial real estate is an industry hit by the Federal Reserve’s interest rate hikes, and any delay in cutting interest rates will prolong the pain for the industry.

Commercial property owners will face a wall in debt maturities this year and beyond, and in many cases landlords will refinance their debt at higher interest rates and lower property valuations.The office industry in particular is in dire shape due to the persistence of remote work and property values. Last month, real estate billionaire Barry Sternlicht said the office market Could cause $1 trillion in damage.

Bank of America says higher rates in the longer term could exacerbate concerns about credit risks commercial real estate loan Repricing, rising borrowing costs create obstacles for homeowners to repay their loans.

Investors were already nervous about regional banks last year, and concerns about New York community banks have resurfaced. Partly because of its involvement in commercial real estate.

In the residential sector, failure to significantly reduce interest rates will result in another year of frozen markets. A repeat of last year, when inventories were extremely low and sales were the lowest since 1995, is likely to be repeated.

“The Fed’s failure to cut interest rates will weaken the housing market,” Rosenberg said.

Prospects for cuts this year

Taking a step back, investors may wonder under what circumstances the central bank is unlikely to adjust interest rates this year.

Regarding inflation and the labor market, analysts at Deutsche Bank said this week that an inflation rate of 2.7% or higher and an unemployment rate of 4% or lower may allow the Federal Reserve to maintain a hawkish stance.

Recent data reflects this situation. Consumer inflation was 3.1% in January, higher than expected. Producer inflation also started to pick up on Friday. The latest non-farm payrolls report showed that U.S. employers added a staggering 353,000 jobs last month.

Nonetheless, Rosenberg does not think the U.S. economy will overheat in 2024.

“We have to be rational people and just say there’s no reason for the economy to re-accelerate this year compared to last year,” Rosenberg said.

He said the market can tolerate high interest rates while the economy is growing, but more rate hikes aimed at curbing inflation would be more damaging.

Read the original article business insider



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