No rally until the Fed starts cutting interest rates

  • The stock market will not experience a sustained recovery until the Fed begins to cut interest rates, JPMorgan said.
  • “As long as central banks raise rates or hold them at current high levels, we believe assets will remain constrained,” the bank said.
  • The Fed will need to see a combination of three things to start cutting interest rates, according to JPMorgan.

The stock market will not see a sustained recovery until the Federal Reserve begins to cut interest rates, and it has no reason to cut them unless a combination of three factors occurs, said JPMorgan in a Monday note.

The S&P 500 jumped 14% from its mid-October low, but growing fear among investors the jump could be nothing more than a bear market rally that will give way room for more decline as the Fed prepares for another interest rate hike next month.

“As long as central banks raise rates or hold them at current high levels, we believe assets will be constrained with more pronounced downside risk,” JPMorgan’s Marko Kolanovic said.

Instead, the Fed must cut interest rates for the stock market to mount a sustained rally that could give way to new highs.

Kolanovic said the Fed could cut rates at some point next year, but only if a combination of factors materialize, including rising unemployment, falling inflation and “something breaking on the financial markets”.

In its bid to rein in high inflation, the Fed has already raised rates by 375 basis points so far this year, and it is expected to raise rates another 50 basis points at its December FOMC meeting. Investors expect another 25 basis point rate hike in January, before the Fed eventually suspends rate hikes to see where the economy stands.

And a resilient economy means the likelihood of interest rate cuts is far off, according to JPMorgan.

“As an increase in unemployment is not likely to happen very soon, markets will be on the edge between waiting for better inflation data, a slowing economy and earnings and rising risks of ‘a financial accident,’ Kolanovic said.

But an economic recession that materializes at the end of 2023 could be the straw that prompts the Fed to ease financial conditions via interest rate cuts and a pause or reversal of its balance sheet reduction program.

“We believe the drag from an anticipated 500 basis point Fed tightening will build and last week we factored a mild recession into our forecast for the end of next year. However, recessions are disruptive events that normally reflect the interaction of Fed tightening with shocks and the response of a vulnerable private sector.This recipe is not yet in place and recession is unlikely to set in as we are entering the new year,” Kolanovic wrote.

Until then, investors shouldn’t put too many stocks in a stock rally unless the Fed shows signs that it’s moving away from tightening and toward easing financial conditions.

Leslie M. Gill