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Fundamental Analysis

Equities Soar on Fed Rate Cut Optimism

  • Powell struck a less hawkish tone than expected at the FOMC meeting.
  • The US jobs report reduced pressure on the Fed to hold high interest rates.
  • The US ISM services PMI fell into contraction in April, indicating slower economic activity.

Equities closed higher on Monday as investors gained confidence that the Federal Reserve will cut rates sometime this year. Moreover, better-than-expected earnings reports from US companies continued to support the market.

S&P 500 (Source: Bloomberg)

S&P 500 (Source: Bloomberg)

Since last week, equities have performed well as policymakers and economic reports point to an eventual Fed rate cut this year. Consequently, the S&P 500 has risen to overbought levels. The first indicator was the FOMC meeting, where Powell struck a less hawkish tone than expected. Although he noted the persistent inflation and the need for more time before cutting rates, Powell confirmed that the next move would be to lower interest rates.

As a result, bets for the first cut in September increased. His remarks showed that although policymakers were less confident about the decline in inflation, they were comfortable that the current rates would eventually lower price growth. Therefore, the risk of a return to rate hikes fell significantly. 

After that, investors got more positive news when the US Labor Department reported a bigger-than-expected drop in employment in April. At the same time, the unemployment rate rose, signaling easing conditions in the labor market. This report reduced pressure on the Fed to hold high interest rates. The labor market has been a significant driver of inflation. Therefore, poor demand in the sector will eventually translate to lower inflation. However, this can only happen if the downtrend continues. 

Moreover, the ISM services PMI fell into contraction in April, indicating slower economic activity. This was another sign that high interest rates were cooling the overheated economy. After these reports, markets expect 46 basis points of Fed rate cuts in 2024, with the first in September or November.

Meanwhile, policymakers maintained Powell’s message on Monday that interest rates no longer need to rise. Fed’s Thomas Barkin said the current interest rates should cool the economy and lower inflation to the central bank’s 2% target. Similarly, John Williams noted that although the central bank might cut rates in the future, monetary policy was in a good place.

Furthermore, the recent upbeat earnings reports added to the positive momentum. Most S&P 500 companies have reported better-than-expected earnings despite the high borrowing costs in the country.