Explore the potential consequences for the economy and financial markets if the Federal Reserve maintains current interest rates.
What will happen to stocks, bonds and the housing market if the Federal Reserve (“the Fed”) does not cut interest rates this year?
That’s what seems to be on everyone’s mind.
Investors have been betting on rate cuts since last November, and this assumption has been the main driver of the excellent stock returns through March 31, 2024.
What seemed so obvious six months ago no longer seems to be relevant. Why is that? Two main reasons:
For credibility reasons, Federal Reserve Chairman Jerome Powell cannot afford to make another mistake by cutting short-term interest rates too soon.
READ: Unprecedented impact of soaring interest rates: What it means for the economy
Their first mistake was calling inflation “transient” in 2021, which meant they had to play catch-up to get inflation under control.
The Fed raised short-term rates 11 times to reduce inflation by more than 9%. Currently, the Fed is concerned about cutting rates too soon, which could reignite inflation by making the economy even stronger through looser monetary policy.
Other factors coming into play in the Fed’s decision-making process are geopolitical tensions between Israel and Iran, as well as Russia and Ukraine. The two conflicts could cause oil prices to rise even further and the U.S. dollar to strengthen. Rising oil prices are inflationary, and a stronger dollar hurts U.S. exporters’ foreign sales.
Sotck exchange
In the middle of this month, the stock market gave up 6% of the 10% cumulative returns at the end of the first quarter of 2024.
If the market falls 10%, it would be considered a correction.
Much will depend on whether corporate profits in the first quarter come in better than expected. More importantly, companies are giving optimistic earnings forecasts for the future.
Today, the stock market is expensive, trading at a price-to-earnings multiple of 20 when the average is 16. Inflation reports will be key to determining whether the Federal Reserve can cut short-term rates. Investors will closely watch the Consumer Price Index (CPI), Personal Consumption Expenditures (PCE), and monthly employment figures to influence any interest rate decisions by the Fed.
Oil prices and geopolitical conflicts could play into investors’ appetite for riskier assets like stocks. We haven’t had a 10% correction yet in 2024, so I think we’re expected to, and it could happen as early as now.
If so, investors might consider a more defensive posture and buy dividend-paying stocks that have underperformed Magnificent Seven AI/technology stocks. Energy, healthcare, financials and consumer staples companies could prove to be good alternatives with attractive dividends.
READ: How to Invest in 2024 — Insights from Wealth Managers and Stock Market Experts
Bond market
The bond market continued to mislead investors this year. Interest rates were supposed to fall in 2024, starting with the first cut at the Federal Reserve board meeting in March.
With higher inflation and a stronger economy, the Fed may not cut interest rates at all in 2024. Longer duration or more interest-rate-sensitive bonds have penalized investors with losses in 2024 A safer bet might be to stay short on the yield curve and buy Treasury bills or a 2-year bond.
Bond funds tend to hold bonds with maturities between 4 and 7 years. They will therefore not perform as well as Treasury bills or 2-year bonds if rates stay there or rise. The yield curve is always inverted, meaning that investors receive more interest on short-term bonds than on long-term bonds. If you have money in the stock market, you may not want to take any risk in the bond market; stay short with higher returns.
READ: Exploring opportunities in the global stock market
Mortgage Rates
Unfortunately for new home buyers, mortgage rates today are still well above 7%.
The current 30-year mortgage is 7.5% and even a 15-year mortgage is 6.9%. Buyers and real estate agents were hoping mortgage rates would be available around 6% in 2024, but with the Fed not cutting interest rates, it seems unlikely there will be much relief on the mortgage front.
Buying a home remains unaffordable for most Americans.
During the COVID-19 pandemic, mortgages could be found at rates ranging from 3% to 4%, but at 7.5%, the monthly payments are simply too high and unattainable. Americans also don’t want to sell their current home and move, because they would give up their incredibly low mortgage rate and double their monthly interest payments when purchasing a new home.
This dilemma causes property prices to remain high because there is no supply on the market. For those needing to purchase a new home, there is once again a lot of competition with multiple offers.
READ: Colorado Housing Affordability Crisis – Denver, Colorado Springs and Grand Junction See No Signs of Improvement
The essential
Stock returns depend on the evolution of the bond market. Typically, when interest rates fall, the value of the stock market increases because investors have an increased appetite for riskier investments like stocks.
Conversely, in a rising interest rate environment like the one we experienced in 2022, the stock market fell by double digits. The huge rally in stocks since November 2023 was based on hopes that the Federal Reserve would bring inflation back to its 2% target and that we would experience a soft landing, meaning a strong economy and lower rates.
However, inflation is stuck around the 3.5% level, meaning the Federal Reserve can’t lower interest rates anytime soon, and probably not at all this year. Some economists even think the Fed may need to raise interest rates in 2024 to bring inflation back to 2%. This scenario is certainly not yet priced into the market, and this outcome would most likely result in a sell-off or a new bear market. Only time will tell.
Fred Taylor is a partner and managing director at Beacon Pointe Advisors, LLC. The information contained in this article is for general information purposes only. The opinions referenced are as of the date of publication and are subject to change due to changes in market or economic conditions and will not necessarily come to pass. Forward-looking statements cannot be guaranteed. Past performance is no guarantee of future results. Beacon Pointe has used reasonable professional care in preparing this information.
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