Opinion
Investors bet on later Fed cuts to support markets after pause
Markets are pricing in the next likely cut in June, but some investors say further easing could come sooner
The choice of Kevin Warsh to lead the US Federal Reserve clears uncertainty on Wall Street about the central bank’s likely next chair, but leaves investors weighing how the former Fed governor’s past hawkish leanings will mesh with President Donald Trump’s insistence on far lower interest rates. Warsh, whom Trump nominated to lead the US central bank, ending a months-long process, had been one of four candidates widely tipped as potential successors to Jerome Powell, whose term as chair ends in May.
A proponent of tighter monetary policy as a Fed governor from 2006-2011, Warsh said recently that Trump is right to press for interest-rate cuts. "He was considered a hawk, but recently he seems to have aligned himself with Trump, so it’s kind of difficult to assess how the market is going to accept this nomination,” said Peter Cardillo, chief market economist at Spartan Capital Securities in New York. "We just have to see whether or not he will be influenced by the White House.”
The Fed held rates steady earlier this week at the end of its two-day policy meeting, pausing an easing cycle which has supported US stocks. Interest rate futures priced in the next rate cut at the June meeting, which would be under the next Fed chair.
"Our two cents is that the economy is doing okay, but inflation is a bit sticky, and the Fed was right to stand pat,” said Tim Holland, chief investment officer at wealth management service provider Orion in Omaha, Nebraska. "We would be very surprised if we get another rate cut with Mr. Powell at the helm.”
While investors anticipated the Fed to pause its easing cycle at the meeting, they are banking on the central bank maintaining a dovish posture with more cuts later in the year that can support equities and the economy. Markets are pricing in the next likely cut in June, but some investors say further easing could come sooner, while others say that inflation worries could prevent more cuts entirely this year.
Investors noted the calm market reaction to Wednesday’s decision, given that Fed meetings often result in wild swings for assets. The benchmark S&P 500 ended little changed on the day, after breaching the 7,000 level for the first time during the session.
The US dollar index largely held its daily gain following the meeting, as it rebounded from a four-year low. The benchmark 10-year Treasury yield moved modestly higher on the day to about 4.25%. "The market didn’t react much to this, largely because Powell has two more meetings,” said David Seif, chief economist for developed markets at Nomura. "To the extent that Powell wants to give forward guidance, there’s a clear expiration.”
A weakening jobs picture had prompted the Fed — which seeks to maintain stability in employment and inflation — to lower rates last year to its current level of 3.50-3.75%. The committee cut that rate by a quarter of a percentage point at its meetings in September, October, and December following a nine-month pause.
On Wednesday, Powell said the job market has shown "some signs of stabilisation”, while inflation "remains somewhat elevated”. "You would need for those dynamics to change in order for the Fed to cut rates again during Chairman Powell’s term,” said Michael Arone, chief investment strategist at State Street Investment Management. Fed funds futures suggested a less than 30% chance of a cut at either of the next two meetings in March and April, but a 65% chance of one in June, according to LSEG data late on Wednesday. Markets were still pricing in nearly two more quarter-point cuts by December.
Still, Drew Matus, chief market strategist at MetLife Investment Management, said a cut could come in March, adding that "people are being maybe a little overly optimistic that the outlook is very clear”. Matus said the current environment is a "good opportunity to be moving up in quality for assets”, including shifting away from high-yield fixed income and other riskier strategies. Investors are trying to anticipate policy once Powell hands over the baton, including the extent to which the next leader will lean more dovish.