Wall Street not happy with Fed’s recent rate increase.

Wall Street Pessimistic as Markets Brace for Rate Cut

Markets may have just survived the last of the most aggressive rate hikes in four decades. However, few on Wall Street are celebrating. If Wednesday’s quarter-point hike marked the peak of the cycle in the US, as market-implied odds suggest, the prospects for risk assets look glum. That’s in sharp contrast to the prior seven tightening cycles, where the final hike has almost always driven rallies in stocks and riskier credit. The one exception came at the end of the dot-com era in 2000 when recession pressures were beginning to build in the economy.

What’s different now?

Swaps traders expect the Federal Reserve’s next move will not be an extended pause, but instead a rate cut, perhaps as soon as July. Such a U-turn to easy policy suggests a recession that will force the central bank’s hand. Add beaten-down US regional bank stocks and tepid profit forecasts from Corporate America into the mix, and the outlook is grim.

Strategists at Wall Street’s largest banks are similarly pessimistic:

• Morgan Stanley predicts the S&P 500 will decline to 3,900 by the end of the year as the economy slows
• Goldman Sachs sees no post-pause gains for US stocks in the second half, forecasting the S&P 500 will end the year at 4,000
• Bank of America Corp. strategists urge investors to “sell the last rate hike” and also see the S&P 500 rounding out the year at 4,000

Many risk assets have already priced in a turn in Fed policy — but not the economic damage that may come along with such a pivot. Corporate balance sheets are in better shape this time, but the bond market is signaling impending recession. Virtually the entire Treasury curve is inverted, a reliable harbinger of an economic slide.

Morgan Stanley strategists recommend investment-grade fixed income. High-grade credit has posted gains after every Fed pause since 1984 and delivered an average return of 9.6%. But inflation remains stubbornly high and that will pressure profits.

Expectations for steep rate cuts are building. Swap contracts linked to Fed meeting dates have been tumbling as markets are pricing in around 70 basis points of cuts by the end of the year.

“We can’t see how the Fed would be cutting rates in the absence of a meaningful slowdown in the US economy,” said Johanna Kyrklund, chief investment officer at Schroder Investment Management Ltd., who is bearishly positioned on US equities. “Something has to give.”