Equity markets that have recently shown strong gains could adopt a more cautious stance if the Federal Reserve restarts policy easing later this week, according to analysts at JPMorgan Chase.
Investors appear to have taken comfort in the prospect of lower borrowing costs, using it to “look through” recent soft U.S. labor market data, the analysts noted. Major U.S. stock indices have hovered near record levels, with the Nasdaq Composite in particular hitting a fresh all-time closing high on Friday.
“But the risk is that this changes,” they wrote. “Once the easing resumes, equities could turn more cautious for a bit, and price in some more downside risk, in effect repricing the current, potentially complacent, stance.”
In a client note, the JPMorgan team led by Mislav Matejka pointed out that historically, broad indices tend to consolidate when the U.S. central bank resumes a cycle of rate cuts, adding that stocks then “stall[ed] for a few months, and would advance thereafter.”
Traders are now almost certain that the Fed will cut interest rates at the conclusion of its latest two-day meeting on Wednesday. Signs of a softening U.S. labor market underpin expectations that policymakers will approve the first rate reduction since pausing cuts in December. While lowering rates can theoretically boost investment and hiring, it may also risk adding inflationary pressure.
Last week, the monthly U.S. consumer price index increased slightly due to rising housing and food costs, indicating potential sticky inflation. Meanwhile, a separate gauge showing a rise in weekly initial jobless claims likely kept the path to a rate cut on track. According to CME’s FedWatch Tool, there is currently about a 95% probability of a 25-basis-point reduction and roughly a 5% chance of a half-point cut. The Fed’s target rate now sits between 4.25% and 4.5%.
Amid this environment, the JPMorgan analysts maintained their “bullish view” on emerging market equities, describing them as “underowned” and trading at “attractive” valuations. They also noted that the “worst” of trade-related uncertainty has now passed.
At a sector level, mining stocks were highlighted as likely to “perform better,” driven in part by a “stronger outlook” in China. The analysts also reiterated their support for long-duration government bonds and warned that a recent July-to-August stabilization in the U.S. dollar “might not last.” The dollar index, which tracks the greenback against a basket of other currencies, is expected to decline 4%-5% over the next six months.
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