This week, the Federal Reserve held its most important meeting in recent history, with all investors' attention focused on one question: Did the Federal Reserve initiate a timely rate-cutting cycle to prevent the economy from slowing down too quickly?

On Wednesday, as scheduled, the Federal Reserve announced an interest rate cut, lowering rates by 50 basis points. This is the first time in more than four years that borrowing costs have been reduced and investors have been assured that this large rate cut is meant to protect the resilient economy, not as an emergency response to recent weakness in the labor market. In the days leading up to the meeting, the market was uncertain about the extent of the interest rate cut, and the probability remained almost unchanged until Wednesday morning.

The outlook of Federal Reserve Chairman Powell may be a key factor influencing the stock and bond markets for the remainder of 2024.

The prospect of a 'soft landing' has bolstered the stock and bond markets this year, but signs of weakness in the labor market have raised concerns that the Fed's actions may be too late.

Eric Beyrich, Co-Chief Investment Officer at Sound Income Strategies, an investment consulting firm, said: 'At the moment, it seems that the market is pausing to digest the surprising news. There are still people wondering, 'Wow, if the Fed cuts rates by such a large amount, what signs are they seeing that indicate the economy will worsen?''

The market reacted relatively calmly on Wednesday, with US stocks, US Treasury bonds, and the US dollar giving back their initial gains after the Federal Reserve's announcement. The S&P 500 index fell 0.3%, after briefly rising 1% during trading. The index has risen nearly 18% this year, nearing its all-time high.

In his comments after the interest rate decision, Powell called it a "realignment" to explain the sharp decline in inflation since last year, and said the Fed hopes to stay ahead of any potential weakness in the labor market.

Some investors are skeptical of this optimistic view.

Wilshire's Chief Investment Officer, Josh Emanuel, said, "Despite what Chairman Powell said at the press conference, the 50 basis point move does indicate concerns that they are falling behind the curve."

Emanuel said that he had increased his bond holdings before the meeting and preferred investment-grade credit over riskier high-yield bonds before the economy deteriorated.

However, many others believe that the rate cut is a positive development for the market and will boost the economy.

Jeff Schulze, Managing Director of Economic and Market Strategy at ClearBridge Investments, said, "I think it greatly increases the Fed’s ability to stick the landing, which will ultimately be bullish for risk assets."

In fact, as long as the economy doesn't fall into a recession, the stock market performs well after rate cuts. Data from Evercore ISI since 1970 shows that the S&P 500 Index has averaged a 14% increase in the six months following the first rate cut by the Fed during non-recessionary periods. In contrast, during a recessionary period, the same time frame experienced a 4% decline after the first rate cut.

Rick Rieder, Global Fixed Income CIO at BlackRock, said that investors may be overreacting to recent weaker-than-expected labor market reports. Other data, such as estimated GDP growth, continue to show that the economy remains resilient.

He said, "I think the market is once again ahead of itself in interpreting the very weak data. Powell said the US economy is very solid, and the facts prove it."

Fed officials also updated their views on interest rates in their latest June forecast. While they now expect a larger rate cut, their rate forecasts are still higher than the market's expectations for the Fed to adopt looser policies.

The Fed said it expects the federal funds rate (currently in the range of 4.75% to 5%) to reach 3.4% by the end of next year, while rate traders are betting on around 2.9%. In addition, the Fed's endpoint for interest rate cuts has been slightly raised from 2.8% to 2.9%.

This divergence may have triggered a reversal in the US bond market, leading to the sell-off of long-term Treasury bonds on Wednesday. The yield on the benchmark 10-year Treasury bond is currently hovering around 3.73% after reaching its lowest level since mid-2023 earlier this week.

John Madziyire, head of US Treasury and TIPS at Vanguard Group, said, "In terms of the pace of rate cuts, I think this is the right response." He is betting that long-term Treasury bond yields will rise.

Others are looking further ahead, with some pointing out that the outcome of the US presidential election could complicate the path of future rate cuts.

Andrzej Skiba, head of US Fixed Income at Royal Bank of Canada Global Asset Management, said, "If a trade war erupts during Trump's presidency, it could have a negative impact on fixed income. This would lead to inflation and limit the Fed's ability to cut rates."

Editor/ping