Quarterly Outlook
Macro Outlook: The US rate cut cycle has begun
Peter Garnry
Chief Investment Strategist
Chief Investment Strategist
Summary: The FOMC language yesterday pushing back at the market’s pricing on a rate cut coming in March was a bit of surprise to the market. We go through the various arguments for why the Fed is hesitating on cutting the policy rate and also the key reasons why the Fed should cut the policy rate and continue over the next 12-18 months.
Did the Fed provide a hawkish or dovish message yesterday in its FOMC statement and subsequent press conference? Some are arguing that it could be both depending on how you look at the message. Judging purely from the reaction in equities the interpretation was hawkish and the market is interpreting Powell’s words that a rate cut is most likely not coming in March. In other words, if the market is right the cutting cycle starts in May. Some are surprised about this development, but there are plenty of indicators suggesting that the Fed should remain cautious and not do a victory lap too early (see below). When we mean cautious, it is not about starting the cutting cycle but at what pace the Fed will go with. Some suggests 250 bps of cuts in the 12 months post the first rate cut in May, but that may be too aggressive if the economy is humming along.
When you take all the observations above into account, and combine it with Powell’s previous comments when inflation erupted that the Fed’s models were broken on forecasting inflation, then it is reasonable that the Fed is hesitating to cut the policy rate.
What are some of the considerations that the Fed should weight in relation to cutting the policy rate?
What are some the ways to express your views on the Fed?
If you believe the Fed will start the cutting cycle in May and then go aggressively towards the neural rate then technology, car, renewable energy stocks should be the segments within equities with the highest positive response function to lower policy rates because of their high equity valuations (technology and renewable energy) and high capital requirements (car industry). If one wants to express the view that the economy will cool down fast and that the market is wrong on rate cuts (too few rate cuts priced in) then this is done in SOFR futures. One would be long the SOFR Mar-2025 contract if one believes the Fed must be more aggressive on monetary policy than what is priced in.