Are Fed rate cuts still possible this year?

Executive summary:

At its May meeting, the U.S. Federal Reserve said 'greater confidence' on the path of inflation is needed
We believe that September rate cuts are possible if U.S. inflation moderates
First-quarter European earnings are beating expectations

On the latest edition of Market Week in Review, Chief Investment Strategist for North America, Paul Eitelman, and Equity Manager Research Analyst Michelle Batjargal discussed key takeaways from the U.S. Federal Reserve's (Fed) policy meeting, as well as the market impact. They also provided an update on how first-quarter earnings season is shaping up around the globe.

Key takeaways from the Fed meeting

Batjargal kicked off the conversation by noting that, as widely expected, the Fed left interest rates unchanged at 5.25%-5.50% at the conclusion of its 30 April -1 May meeting. "As a general rule, the Fed doesn't like to surprise financial markets on rate decision days, and they sure didn't this time around," Eitelman remarked, adding that market participants were more focused on seeing how Fed officials are processing U.S. inflation data. He explained that the recent stretch of generally hotter-than-anticipated inflation numbers has led to a notable repricing in the amount of rate cuts markets expect in 2024.

In the press conference following the meeting, Fed Chair Jerome Powell reinforced two main messages for markets, Eitelman said. The first was that it will likely take the Fed longer to gain confidence that inflation is moving toward its 2% target meaning that the timeline for the first potential rate cut will likely be pushed further out. The second message, Eitelman said, was that Powell believes it's unlikely the Fed will need to hike rates again in the short term.

"Chair Powell reiterated that he believes the current policy rate is restrictive enough to bring inflation down over time," Eitelman said, adding that although many investors were already assuming as much, it was encouraging for markets to hear this directly from the Fed chair himself. Going forward, Eitelman stressed that the Fed is likely to continue taking a very data dependent approach to monetary policy. "If inflation declines further, I think the Fed will eventually start cutting rates. If inflation stays stubborn, it's likely that the U.S. will be in a higher-for-longer rate regime," he said. Eitelman added that his expectation is for U.S. inflation to start moderating over the course of the year, and said that if this happens, the Fed could start cutting rates in September.

He concluded by stating that markets experienced an uptick in intraday volatility the day of the Fed announcement, with traders seemingly hinging on every word Powell said. This sparked big upward and downward moves in both equity markets and Treasury yields on May 1, Eitelman said. "At Russell Investments, our trading and transition management teams had been expecting heightened volatility, due to the combination of the Fed meeting and reduced liquidity over the May Day holiday," he stated, stressing that it's important for institutional investors to have an awareness around potential market volatility in order to avoid taking uncompensated risks.

How is first-quarter earnings season shaping up globally?

The conversation shifted to first-quarter earnings season, which Eitelman said is generally going well globally. In the U.S., the season started rocky, with some big banks reporting underwhelming results, but the picture has since brightened, he observed. "Right now, S&P 500 companies as a whole are tracking toward high single-digit earnings growth. Not only is this a positive surprise relative to market expectations, but it's a pretty healthy fundamental growth rate for the U.S. corporate sector," Eitelman remarked.

He said that in another bright spot, forward guidance from company management teams has generally been in line with, or even a tad above, consensus expectations. This is welcome news for investors, he pointed out, as markets are typically mostly forward-looking.

Eitelman added that in Europe, corporate earnings are also surprising to the upside, with some strong performances from companies in Asia as well. "Ultimately, across the globe, first-quarter earnings are looking fairly solid so far," he concluded.

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Any opinion expressed is that of Russell Investments, is not a statement of fact, is subject to change and does not constitute investment advice.