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Fed rate cut could become a double-edged sword

With valuations already high, further easing could lead to a bubble, analysts say

Global equities on Thursday cheered the US Federal Reserve’s move to cut its benchmark rates by a mega 50 basis points, easing fears of a soft landing of the world’s largest economy.

In the UAE, the Dubai Financial Market General Index rose by 31.32 point or 0.71 per cent, to close tat 4421.52 points. In Abu Dhabi, the FTSE ADX General index surged by 77.63 points or 0.82 per cent, to close at 9,500.22 points.

In the US, at 09:46am EST, the Dow Jones Industrial Average rose 391.24 points, or 0.94 per cent, to 41,894.34, the S&P 500 gained 72.37 points, or 1.29 per cent, to 5,690.63 and the Nasdaq Composite gained 377.68 points, or 2.15 per cent, to 17,955.01.

While overall markets and analysts are welcoming the move, some, however, advise a note of caution.

“The Fed’s rate cut is a double-edged sword for the stock market. While it has the potential to boost economic growth and stock prices, there are also risks associated with excessive monetary easing. Investors should carefully consider these factors when making investment decisions,” Mohamed Hashad, Chief Market Strategist, Noor Capital, said in a note.

The rate cut is expected to have several positive implications for the stock market. “Lower interest rates reduce borrowing costs for businesses and consumers, which can stimulate economic activity and boost corporate profits. This, in turn, can lead to higher stock prices. Additionally, rate cuts can make equities more attractive relative to other investments, such as bonds,” Hashad wrote.

However, the impact of the rate cut on the stock market is not entirely positive. Some analysts argue that the current market valuations are already high, and further stimulus could lead to a bubble. “Moreover, the effectiveness of rate cuts in boosting the economy may be limited if other factors, such as trade tensions and geopolitical risks, are weighing on growth,” Hashad added.

According to Guy Stear, head of developed markets strategy at Amundi Investment Institute, the big news is not so much the 50bps cut, but rather the trimming of growth forecasts and the sharp downward revision of the dots. “The Fed seems confident that it has won the battle against inflation, and recognizes that monetary policy is now too restrictive, especially given the threats to growth,” he said.

Lombard Odier analysts see the US central bank making 25 bps cuts in each of the remaining meetings this year. “If recession risks were to materialise, it has scope to ease policy more substantially,” a note written by Bill Papadakis, senior macro strategist and Kiran Kowshik, global FX strategist said.

Curency-wise, the Fed’s move is likely to continue to put pressure on the US dollar. “We believe the Fed’s policy path is converging towards market expectations, and that means less support for the US dollar going forward. We have turned neutral on the dollar overall and the Swiss franc and Japanese yen are now our most preferred currencies,” they added.

The FOMC meeting shows the immense uncertainty surrounding the path ahead, Saxo Bank analysts said. “The first dissent today since 2005 highlights the growing challenges the Fed faces. Mixed economic signals have made policymaking more difficult as the Fed struggles to balance various competing forces. This is reflected in the dispersion of the dot plot, where two members now indicate no more rate cuts for 2024, while the median expectation points to another 50bps of cuts. The divergence suggests we could see more than one dissenter in future decisions, especially with the possibility of a 25bps cut in November,” Charu Chanana, head of FX Strategy at Saxo Bank, said.

While the direction of travel is evident, the speed is far less certain, analyst say. “The Fed’s soft landing remains the primary goal, but the revision of the neutral rate higher and limited forward guidance will likely keep markets volatile,” Hashad said.

The Fed is balancing the need to support economic growth with inflation risk. “If inflation starts to rise, the central bank may need to reverse course and raise interest rates again. This could lead to a volatile market environment,” Hashad added.