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Stocks may rise or jump depending on why Fed cuts rates



Traders work on the floor of the New York Stock Exchange.

Brendan McDermid | Reuters

The Federal Reserve is expected to cut interest rates several times this year, but the economic backdrop driving these cuts may have very different stock market implications. The story shows.

And unfortunately for investors trying to bet on the result is that the driver is not always ready when the central bank starts an interest rate cut cycle.

"Broad stock index performance after the start of Fed interest rate cuts depends on whether the economic downturn was a soft patch or a more severe economic downturn," Maneesh Deshpande, head of US equity strategy in Barclays, wrote in a note last week. [1

9659002] Data prepared by Barclays shows that S & P 500 increases more than 21% a year after the central bank lowers rates as a hedge against what turns out to be a soft patch in the economy. Strategists refer to this as an "insurance rate" cut.

However, the S & P 500 is a loss of about 17% when the Fed lowers rates due to what turns out to be a recession.

"The previous two Fed cut rates for the first time in 2001 and 2007, we saw that stocks are ultimately halved," says Ryan Detrick, senior market strategist at LPL Financial, in a post. "But the reality is, if you go back further in time, you can also see explosive rallies after the first cut."

Wall Street will get track of where the Fed is on the economy and monetary policy on Wednesday after the central bank finishes a two-day political meeting. Some economists and investors even believe it is possible that the central bank will cut this week. The Fed meeting comes amid the deterioration of economic data and fears that the ongoing trade war between the United States and China is weakening the global economy. But it is not clear whether it is a soft patch or not. Barclays & # 39; Deshpande said the recent sectors' performance points to the former.

Production activity grew at its slower pace since October 2016 last month. Meanwhile, job creation has been lowered to just 75,000 in May, which lacks expectations. The US economy is also seen as growth of 2.1% in the second quarter, more than a full percentage point in the first quarter.

Meanwhile, China and the United States have not yet entered into a trade agreement. Minister of Commerce Secretary Wilbur Ross also said on Monday that President Donald Trump would be "completely satisfied" with hauling additional tariffs on Chinese goods.

This has sent expectations for a smaller monetary policy increase. Market expectations for a rate cut in July were 84.3% on Monday, according to the CME Group's FedWatch tool. Bets for another rate cut in September were 65%. Traders have also priced in a 51.9% chance of a third rate cut in December.

Some even think the Fed could start lowering rates even earlier. Jim Grant, editor of Grant's Interest Rate Observer Newsletter, told CNBC's "Squawk Box", the Fed will reduce rates on this week's meeting. Grant Thornton's finance director Diane Swonk believes the Fed should cut rates this week.

But David Lafferty, Marketing Manager at Natixis Investment Managers, believes the market is priced in too many interest rate hikes.

"I think the Fed wants to stick, maybe even reduce rates once, but I don't think the Fed will go anywhere near what the market is priceing right now," Lafferty said. Two or three cuts, "it's a full-time Fed. It's the Fed that tells you that a recession is coming. If the Fed can hold on to or even give the market a taste of what it wants, without going into full retreat, That would be supportive of stocks. "

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