The next few months are likely to witness the Federal Reserve making a cut to its benchmark federal funds rate, after plenty of speculation. Concerns over a cooling labor market and a slowdown in economic growth appear to be the driving factors. Combine that with stagnant real wage growth and a retreating consumer base burdened with over $1 trillion in credit card debt, and it becomes clear that the Fed is being prodded towards action.
Recent numbers on initial jobless claims, i.e., workers applying for unemployment benefits, lend more weight to this view. Even with inflation refusing to dip below the central bank’s 2% target, the Fed has sufficient grounds to go ahead with a rate cut. A worrying detail is the dramatic slowdown in the growth of GDP, with the Atlanta Fed’s GDPNow model for the second quarter projecting a mere 2%. While not alarming, it doesn’t make for encouraging news either.
Thus, the conditions seem ripe for the Fed to initiate a rate cut. However, it raises the question – what would be the aftermath of such a move?
One might wonder whether the market will welcome or shun the Fed’s first rate cut. Is it going to be a boon or a bane?
There’s an existing belief that a Fed rate cut, signifying an easing, can invigorate markets. It’s commonly understood that lower-interest-rate conditions can favour growth-oriented companies sensitive to borrowing costs. This theory might very well hold true, especially for small-cap stocks. However, it is not an assured phenomenon.
Historical patterns show that a Fed rate-cutting cycle often preempts a significant correction in equities or even a full-blown recession. It’s uncertain whether the Fed has been overzealous with its rate hikes. If it has and if that triggers a stock market panic in response to the rate cuts, the central bank will have to react accordingly.
At present, we’re unsure if a rate cut will occur this year, let alone how the market will respond. However, a certain truth is that the Fed doesn’t have a superpower – it cannot predict tomorrow better than the rest of us. This unpredictability serves as a potential risk for stocks.
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