Investors are expecting rate cuts. But what happens to markets if they don't come this year?
Gambling on rate cuts has been a major theme in 2024, but as a string of hot economic data points has kept the Federal Reserve on its toes, some in markets have begun to wonder: what if the Fed doesn't cut this year?
"More confidence needed" is the mantra Fed Chair Jerome Powell has been repeating, remaining crystal clear about the central bank's goal of bringing the inflation level closer to 2% target.A spike of 3.3% in fourth quarter GDP, an influx of 353,000 new jobs in January, and inflation at 3.1% are all data points that are complicating Fed policy, and upsetting markets eagerly waiting for interest rates to come down.
Stocks to stay strong, but bonds to suffer
Bank of America analysts said in a note this week that S&P 500 stocks should still be favorably positioned, regardless of coming Fed moves.
Other market pros echoed this and said that while no cuts is not a likely scenario, the business cycle should be supportive of 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 will likely be healthcare and then consumer staples," David Rosenberg, economist and the founder of Rosenberg Research, told Business insider.
For bonds, higher-for-longer would be a different story.
Rosenberg said there's 90% correlation between expectations for monetary policy and longer-term treasury bond yields, emphasizing that investors could see the 10-year Treasury tick back up to 4.7%, not a far cry from the multi-decade highs seen at the end of last year.
One thing that keeps investors on guard is banks' holdings of many lower-yielding bonds. Those bonds, which offer low returns, can't offset the banks' higher funding costs in a high-interest rate environment, creating a "negative carry" risk, the analysts said.
Rosenberg echoed the potential risks to the banks.
"If [the Fed] doesn't cut rates because it remains concerned over inflation, as opposed to the economy, it is going to be decisively negative for the bank stocks," Rosenberg added.
A wall of debt maturities is coming for commercial property owners this year and beyond, and landlords in many cases will be refinancing debt at higher rates and lower property valuations. The office sector in particular is in a dire state as remote work persists and property values plunge. Last month, real estate billionaire Barry Sternlicht said the office market could see $1 trillion of losses.
BofA said higher-for-longer rates could intensify worries over credit risks stemming from commercial real estate loan repricing, with elevated borrowing costs creating hurdles for property owners to repay their loans.
In the residential sector, failure to bring rates down meaningfully would lead to another year of frozen markets. It would likely be a repeat of last year, when inventory was woefully low and sales were the lowest since 1995.
"The real estate market would be undercut by the Fed's failure to cut interest rates," Rosenberg said.
The outlook for cuts this year
Regarding inflation and the labor market, Deutsche Bank analysts this week said that inflation at 2.7% or higher, along with an unemployment rate of 4% or lower, could keep the Fed hawkish.
Still, Rosenberg doesn't see the US economy overheating in 2024.
Markets can withstand high rates while the economy is growing, he said, but more rate hikes aimed at curbing inflation would be more disruptive.
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