Interest rate cuts coming soon, will the US stock market stabilize?

After two consecutive days of the interest rate meeting, the Federal Reserve kept the federal funds rate unchanged at 5.25%-5.50%, marking the eighth time the central bank of the world's largest economy has held steady. Since the 25 basis point rate hike on July 27, 2023, the Federal Reserve has maintained the interest rate unchanged in subsequent meetings, as shown in the table below.

At the same time, the Federal Reserve indicated that it will continue to reduce its bond holdings.

However, what excited the market was Powell's revelation during the press conference that a rate cut in September "may be on the agenda," provided that inflation data meets expectations. He also hinted that the Federal Reserve may cut rates several times this year, but it could also choose not to cut rates at all.

Boosted by this news, the U.S. stock market performed well, with the Dow Jones Industrial Average rising slightly by 0.24% on the last trading day of July, while the previously pressured NASDAQ index (IXIC.US) surged by 2.64%.

Does this mean that once the rate cut cycle is clear, the U.S. stock market will forge ahead? Probably not.

How does the FOMC express its stance?

In the interest rate statement, the Federal Open Market Committee (FOMC) pointed out that the committee's goal remains to achieve maximum employment and to maintain inflation at the target of 2% over the longer run. The committee assessed that the risks to achieving the employment and inflation goals are more balanced. To maintain these goals, the committee decided to keep the federal funds target rate at 5.25%-5.5% and will continue to reduce its bond holdings.

During the press conference, Powell stated that over the past two years, the U.S. economy has made significant progress in achieving maximum employment and price stability: the labor market's supply and demand relationship is more balanced, the unemployment rate remains at a low level, and inflation has significantly decreased from a high of 7% to 2.5%.

Regarding inflation, inflation pressures have eased significantly over the past two years but still remain above the longer-run target of 2%. In the 12 months ending in June, the PCE price index rose by 2.5%; excluding the volatile food and energy categories, the core PCE price index increased by 2.6%.

However, it is important to note that the recent employment data in the United States is weakening.

FinanceAsia observed that the U.S. unemployment rate has risen from 3.6% in March 2022 when the Fed began its rate hike cycle to 4.1% in July this year, as shown in the figure below.

The American employment statistics company ADP revealed that in July 2024, private enterprises in the United States added 122,000 jobs, lower than the previous month's 155,000 and the expected 150,000, marking the lowest in the past six months. This data indicates a continued slowdown in wage growth and a decrease in new job positions.

In the first half of this year, the GDP growth rate in the United States slowed from 3.1% in the same period last year to 2.1%.

Impact on the Capital Market

It is evident that the delayed impact of previous interest rate hikes on U.S. economic growth is now showing. It is estimated that the subsequent cost pressures will continue to affect the overall investment growth of U.S. enterprises and households. The current performance and expectations of listed companies have not fully reflected these factors. In the future, as these impacts unfold, the outlook for corporate growth and profits may not be as optimistic as they are now, especially under the current investment trend driven by the AI boom.

AI requires significant capital investment, and in a high-interest rate environment, the investment costs for AI are also rising (due to high interest rates and opportunity costs). If the results later show that the input into AI does not yield proportional output, it will drag down the performance of large tech stocks.

Amid the current AI boom, the "Seven Sisters of Wall Street" have seen the largest increase. NVIDIA (NVDA.US) has more than doubled its stock price over the past two years, and its market value once surpassed Apple (AAPL.US) and Microsoft (MSFT.US) to become the world's most valuable listed company. Meanwhile, stocks such as Apple, Microsoft, Google (GOOG.US), Meta (META.US), Amazon (AMZN.US), and Broadcom (AVGO.US) have also continued to be sought after.

These highly valued tech stocks are major components of stock indices, and their rise has also driven the overall stock market indices, such as the NASDAQ index that reflects the performance of tech stocks, which fluctuates significantly following the movements of the "Seven Sisters."

If the Federal Reserve continues to maintain high interest rates, damaging economic performance, investment, and demand, the filter of AI optimism will be shattered. These large tech stocks that have been given high valuations due to the optimistic outlook for AI will also revert to their original state. Their stock prices will decline, inevitably affecting the performance of the U.S. stock market indices, thereby causing a shift in sentiment across the entire capital market.

This is why the Federal Reserve is so cautious in its monetary policy direction. Powell emphasized that both premature and delayed rate cuts are not conducive to economic activity and employment. The committee will carefully evaluate economic data, economic outlook, and risk balance before deciding on adjustments to the target interest rate range.

Given the signs of economic slowdown in the data, the Federal Reserve is also hesitant to be too aggressive at high interest rate levels. On the other hand, the continued strength of the U.S. dollar is also unfavorable for its trade situation, and the trade advantage brought about by the depreciation of the Japanese yen may make some U.S. industrial enterprises, especially high-tech companies, feel unfair. Now that the Bank of Japan is starting to raise interest rates, it may somewhat alleviate the pressure of the high U.S. dollar exchange rate, but the effect is minimal. Only when U.S. dollar interest rates start to decline, perhaps will it provide a clearer signal to the market After Powell's statement, the market has basically determined that the rate cut in September is a foregone conclusion, with a 86.5% probability of a 25 basis point rate cut, while the remaining 13.5% believe in a 50 basis point rate cut.

Rate cuts do not necessarily mean that the US stock market will be on a winning streak from now on, as the market and speculators will focus on two issues: whether the rate cut path aligns with the market's general expectations, and the subsequent impact of interest rates. Rate cuts will be implemented gradually, not all at once. After the rate cut cycle begins, high interest rates will still be maintained for a period of time. Coupled with the delayed effects of previous rate hikes, economic vitality may still be restrained for a period of time, thereby affecting the future performance of listed companies and their stock price performance