Wednesday, May 29, 2024

Reality bites as Wall Street’s rate cut dream disappears

by BIZ Magazine

NEW YORK (AP) — After a long staring contest between Wall Street and the Federal Reserve, investors blinked first.

For months, Wall Street doubled down on bets that the Federal Reserve was bluffing about how far it would hike rates. Traders were even forecasting the Fed could begin cutting rates by the second half of this year, which can act like steroids for markets.

Through it all, Fed officials kept saying that they would ultimately raise rates past levels investors were anticipating and leave them there until the fight against inflation was definitely over. They said no rate cuts would likely happen until 2024 at the earliest.

Stakes were high in the standoff because higher rates can stamp out inflation, though at the risk of creating a recession because they slow the economy. Higher rates also hurt investment prices in the meantime.

But a flood of data reports since the start of February have forced Wall Street to bring its forecasts for rates closer to the Fed’s. Key among them were reports showing inflation at both the consumer and wholesale levels isn’t slowing as quickly or as smoothly as hoped.

On top of those, the job market remains resilient even in the face of the most aggressive rate hikes in decades. And strong spending at U.S. retailers gives some assurance that the most important part of the economy, consumer spending, is still holding up.

Such stronger-than-expected data give hope that the economy is not about to fall into a recession. But they also may be fueling more upward pressure on inflation and encouraging the Fed to keep rates higher for longer, which raises the risk of a recession down the road.

That means expectations for rate cuts by the Fed by the end of this year have largely washed out of the market. The yield on the two-year Treasury, which tends to move with expectations for Fed action on rates, on Tuesday was near its highest level since 2007.

That in turn is pressuring stocks, undercutting their big rally to start the year. For investors who piled into the market in January when stocks were rising, it’s a reminder of a longstanding mantra on Wall Street: Don’t fight the Fed.

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