The Fed May Hesitate to Proceed with Rate Cuts This Year, But Will This Definitely Be Bad for The Market?

The Fed's meeting minutes and recent comments from Goldman Sachs CEO both indicate that the possibility of a rate cut is declining. Current inflation is still far from the Fed's target, as the latest house price data shows that the road to fighting residential inflation is getting increasingly difficult.

The minutes of the Federal Open Market Committee's meeting, which took place from April 30 to May 1 and was made public on Wednesday, revealed that officials were uncertain about the appropriate timing for monetary easing.

"Participants observed that while inflation had eased over the past year, in recent months there had been a lack of further progress toward the Committee's 2 percent objective," the summary said. "The recent monthly data had showed significant increases in components of both goods and services price inflation."

The minutes also showed "various participants mentioned a willingness to tighten policy further should risks to inflation materialize in a way that such an action became appropriate."

Since that meeting, there have been modest indications of advancement concerning inflation. The CPI for April indicated that inflation was at an annual rate of 3.4%, which is a slight dip from the rate in March. When food and energy are excluded, the core CPI measured 3.6%, marking the lowest rate since April 2021.

However, consumer sentiment surveys reveal growing concerns. The University of Michigan's consumer sentiment survey disclosed that the inflation expectation for the coming year climbed to 3.5%, the highest recorded since November, and the general outlook weakened. A survey conducted by the New York Federal Reserve indicates similar trends.

The report from the National Association of Realtors on Wednesday showed the median price for existing homes soared by 5.7% compared to the previous year, reaching $407,600, setting a record for the month of April. An increase in home prices was observed across all four regions. Notably, at least 27% of homes sold in the past month fetched prices above their listed values, suggesting that bidding wars were common in certain localities.

Since shelter is a significant component of the CPI, higher home prices can drive up inflation measurements, in turn creating challenges for the Federal Reserve in setting appropriate interest rates.

Goldman Sachs CEO David Solomon has indicated his anticipation that the Federal Reserve will maintain current interest rate levels throughout the year, attributing the economy's robustness in part to governmental fiscal expenditures. "Based on the data I've seen, I find no compelling evidence to suggest that we'll be seeing rate cuts," he commented during an event organized by Boston College. Solomon underscored his forecast for the interest rate outlook, stating he predicts "zero" cuts for the year.

Solomon also said that consumers are already starting to feel the pressure of rising prices.“If you're talking to CEOs that are running businesses that really deal with what I'll call the middle of the American economy, those businesses have been starting to see change in consumer behaviors. Inflation is not just nominal. It's cumulative, and so everything is more expensive.”

According to the FOMC meeting minutes, "several" participants focused on an improved labor-market balance- aided by immigration slowing wage growth, and easing super-core inflation.

The Indeed data shows that job postings in the US have decreased by 9.6% since the start of this year. A more balanced job market may cause future wage growth to decline, thereby reducing service inflation.

Long-term high interest rates will put pressure on asset valuations, but they do not necessarily mean lower prices for all assets.

Its impact on the stock market varies in different economic stages. The stock market decline in 2022 is at the end of the economic recovery, but the US economy has been in an early stage of continuous acceleration since 2024.

The rebound in trade balance growth and the advent of the inventory replenishment cycle confirm the recovery. The reshoring of supply chains, the re-localization of manufacturing, and the continued development of shale oil have promoted the export growth of industrial supplies and materials.

The inventory cycle is another determining factor. Retail inventories excluding autos dropped by 2.4% in March, on a yearly basis. Historically low inventories mean that once demand recovers, it will drive orders across the supply chain, which has been reflected in consumer electronics, memory products, copper and other fields.

Specifically, the impact on the stock market will depend on how sensitive each sector is to interest rate changes, the balance sheets of companies, and the life cycle of the industry.

Generally speaking, it is true that high interest rates will have a negative impact on some highly leveraged industries. For example, the real estate sector sees dampened demand due to costlier mortgages, affecting REITs and real estate stocks. Higher interest rates can also reduce spending in consumer discretionary sector as borrowing costs increase for big-ticket items like cars and appliances. This could negatively impact the earnings of the companies.

However, some sectors could face mixed impacts. If higher rates are a response to strong economic growth, it could signal robust demand, such as for industrial and materials companies' products.

Besides the impact on the stock market, high interest rates may mean that the US Dollar Index could remain strong for the coming period. As for commodities, their prices have to confront the interplay between geopolitical situations and high interest rates, making it more likely that they will maintain wide fluctuations.

According to the FOMC meeting minutes, "many" participants viewed productivity growth as another potential source of disinflation.

The San Francisco Fed, in close coordination with the Federal Reserve System Innovation Office, recently launched the Emerging Tech Economic Research Network (EERN) in May, to better understand how emerging technologies like GenAI are shaping the economy of the future. Some participants believed that GenAI would bring new market opportunities and more corporate profits.

There is no better example of the positive impact of technological progress on the market than Nvidia's earnings report that exceeded expectations on Wednesday. Nvidia's success reflects the active capital expenditures of the US Internet industry and will drive revenue of its upstream supply chain.

In addition to AI, the continuous advancement of autonomous driving of electric vehicles, lower-cost battery technology, precision therapies, and digital payment technology will also have positive impacts on the economy.

As ARK Invest's Cathy Wood says, technological progress helps firms that are dedicated to innovation and productivity expand significantly in the upcoming years. Therefore, new markets brought about by rapid technological progress will largely offset the pressure on valuations caused by high inflation and interest rates.