Goodbye Summer; Hello Pumpkin Spice, Everything.

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Markets spent the week largely treading water, awaiting the highly anticipated results of Nvidia. Death, taxes, and NVDA beats on earnings are three things you can bank on these days. But here’s the issue with that stock and company: The size of the beat this time was much smaller than we’ve been seeing. Even future guidance was raised, but again not by the tune from previous quarters.

More importantly, however, is that the muted reaction out of that stock was actually quite positive for the market as a whole. A day where Nvidia, which is the bellwether for AI, traded marginally lower but the broader market, especially technology and semiconductors, traded higher speaks to the broadening that we’re starting to see in this market rally.

Further, Economic data released Thursday lent support to the stock market. Weekly jobless claims fell from the prior week, further easing US recession concerns. In addition, second-quarter gross domestic product was revised higher to 3% growth from an initial 2.8% rate. So, while we continue to see a “welcomed” cooling in the labour market, the economic backdrop remains strong lending support for the US Fed to slowly begin loosening rates.

It’s no secret that markets have been fixated on – and driven predominantly by – the timeline to Fed rate cuts for the better part of the last year. The wait is almost over, as we think the commentary from Chair Powell is consistent with the prevailing view that interest-rate cuts will commence in September.

The Fed has held its policy rate steady for more than a year now, with the extended pause stemming from the fact that the central bank's dual mandate (stable inflation plus maximum employment) was not yet in a position that could warrant a change in policy settings. With the trends in inflation and employment now both on the move, and with economic growth still positive, but at a slower pace, we expect the Fed's attention will now be more balanced, with an effort to support the labor market and economy.

Removing the extraordinary cutting cycle that we witnessed around Covid, it’s been about 15 years since we had a “traditional” cutting cycle, so we thought a walk down memory lane would be helpful. Historically, the Fed starts cutting rates in response to an economic downturn, a financial shock/crisis, or both (Covid). The conditions are somewhat unique this time, as the Fed is not seeking to address a collapsing economy or arrest a seizing financial system. Put differently, the Fed often cuts rates to press on the gas pedal, stimulating a sputtering economy. This time around it’s more about letting off of the brake, upon which the Fed has had its foot firmly pressed for the last two years.

Given our comments above, we expect this rate-cutting cycle to start, and proceed, gradually. Barring a sharp and unexpected change in the path of inflation or unemployment, we think the Fed will make incremental, 25-basis-point (0.25%) cuts to its policy rate.

The policy-easing cycle that began in 2007 commenced with an outsized cut (0.50%) and included numerous large rate cuts as we navigated the housing market collapse and global financial crisis. Similarly, the easing cycle following the tech bubble pop and 9/11 in 2001 included numerous 50-basis-point rate cuts. We don't see a need at this stage for a dramatic move by the Fed, and in the absence of any particularly weak upcoming jobs reports, we think a string of 25-basis-point rate cuts is the likely approach, as the Fed seeks to find a neutral stance for its policy rate.

We think a shift to a phase of monetary-policy easing will be a tailwind for financial markets over the coming year. That said, this has been widely and eagerly anticipated, so a portion of that benefit has already been pulled forward into the stock and bond markets.

However, we don't think the benefits of lower rates have been fully exhausted for the stock market. The ability for the Fed to lower rates in a manner that orchestrates a soft landing for the economy (avoiding recession) should, in our view, provide scope for corporate profits to rise at a healthy clip next year, which we believe would be a fuel source for this bull market to extend this year and into 2025.

 

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