The US Federal Reserve’s decision to cut interest rates by 50 basis points has sent markets into a tailspin, but many are wondering what the long-awaited dovish shift means beyond a short-term reaction.
The Fed’s move on September 19 was widely expected, with the central bank also promising another 50 basis point cut before the end of the year. This initially sparked a sharp rally, sending the dollar to fresh record highs before a “sell-the-news” reaction sent markets slightly lower by the end of the day.
In the short term, this dovish move has left markets in a generally constructive mood. The main risk factors remain potential negative economic data, but the current economic calendar is light until early October.
In a recent note, Sevens Report said that in the absence of the threat of major earnings reports or major economic releases, investors appear to be operating in an environment of “1) Fed easing, 2) slowing but “acceptable” economic data, and 3) generally strong earnings.”
Cyclical sectors, including energy, materials, consumer discretionary, and industrials, are expected to outperform, while technology may lag in the near term.
But the longer-term consequences of the Fed’s decision could be more complicated. The key question facing investors is whether the Fed has acted in time to prevent a broader economic slowdown.
If interest rates are cut in time, it could lead to lower yields, strong earnings growth and positive economic tailwinds, Sevens said. This would likely lead to continued upward momentum for stocks, with the S&P 500 potentially reaching 6,000.
“I say this with confidence because a timely Fed rate cut would create this macroeconomic outcome: 1) lower yields, 2) continued very strong earnings growth, 3) positive economic tailwinds, 4) a prominent Fed presence and 5) expectations of accelerating growth going forward,” Sevens Report’s president wrote in the note.
On the other hand, if the Fed’s actions come too late to prevent an economic slowdown, the market could face significant risks.
In such a scenario, the S&P 500 could fall to about 3,675, a sharp decline of more than 30% from its current levels. This downside risk mirrors the corrections that markets have experienced in previous recessions, such as those in 2000 and 2007.
As markets digest the Fed’s moves, future economic data will become crucial in determining whether the central bank’s policy is effective.
More specifically, investors will need to watch upcoming releases closely to see whether the Fed has succeeded in steering the economy away from recession or whether further challenges lie ahead.
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