Impact of Interest Rate Cuts on the Stock Market
Impact of Interest Rate Cuts on the Stock Market
In response to rising inflation, the United States Federal Reserve has embarked on an aggressive rate hike cycle, raising interest rates 11 times since March 2022. With inflation now showing signs of cooling, market participants are eagerly anticipating a pivot from the Fed, potentially signaling an impending interest rate cut.
Tempered Expectations
Despite the market’s enthusiasm for a rate cut, OCBC Securities’ Trading Strategist, Samuel Wong, cautions against excessive expectations of an immediate market surge. While lower interest rates reduce borrowing costs and stimulate investment, Wong highlights that the magnitude and timing of the cut are crucial factors.
Gradual Impact
Wong emphasizes that a significant rate cut is unlikely, with Minneapolis Fed President Neel Kashkari downplaying the possibility of cuts larger than a quarter of a percentage point. Additionally, he argues that it often takes a series of rate cuts to provide the necessary market momentum. Wong cites the Fed’s rate cuts during the “Great Recession” from 2007 to 2009 as an example, where it took six months after seven consecutive cuts for the S&P 500 to experience substantial gains.
Inflation as a Wild Card
Wong warns against ignoring the ongoing inflationary pressures, fueled by geopolitical tensions and global supply chain disruptions. He cautions that inflation may not have fully stabilized, potentially limiting the Fed’s ability to implement multiple rate cuts as it did during the “Great Recession.”
Limited Market Upside
Market growth may have already plateaued, according to Wong. The S&P 500 has surged since late October 2022, and the market capitalisation has increased by close to 36%. Wong suggests that these gains may already reflect the market’s anticipation of a rate cut, leaving limited upside potential.
Sector-Specific Opportunities
Instead of anticipating a broad market surge, Wong advises investors to focus on sectors that are likely to benefit from lower interest rates. Dividend-paying industries such as utilities and real estate investment trusts (REITs) typically perform well in such environments, as their yields become more attractive relative to other fixed income investments. Cyclical sectors, such as consumer discretionary and industrials, also tend to thrive in low-interest rate periods. Reduced borrowing costs make capital-intensive industries and those experiencing growth more competitive. Wong specifically mentions consumer discretionary stocks, which include companies selling non-essential goods and services, as being particularly sensitive to changes in consumer spending and likely to perform well in a low-interest rate environment.