Why a Fed rate cut might not help the stock market

Economic

Summary:

Fed cuts may not lift stocks: risk of speculative rally (Yardeni), weak jobs drag (Citi, Apollo), inflation limits easing. Morgan Stanley warns volatility; Goldman sees gains if no recession.

After a weak August jobs report, markets are nearly certain the Federal Reserve will cut interest rates by 25 basis points at its policy meeting next week, with some investors even betting on a larger reduction.

Traders hope a more dovish Fed will boost equities after a choppy summer. But some Wall Street strategists warn that rate cuts may not be all good news for stocks in the near term.

Ed Yardeni, president and chief investment strategist of Yardeni Research, warned Monday that easier monetary policy could spark a destabilizing "melt-up" in US stocks without addressing America's labor supply shortage, strained by President Trump's immigration crackdown and an aging population.

"We think that by cutting rates this month, the Fed would be stimulating an economy that doesn't need easier monetary policy," he said. "Stimulating an economy that doesn't need stimulation won't create more workers to address the undersupply that's constraining the demand for labor."

Yardeni argued that with productivity improving and the unemployment rate still historically low, extra liquidity risks fueling a speculative rally driven by investor FOMO rather than fundamentals — the kind of rally, he warned, that often ends in a sharp correction.

Yardeni isn't alone in his skepticism. Others see the risks of rate cuts outweighing the potential benefits.

Stuart Kaiser, head of US equity trading strategy at Citi, called August's weak payrolls report a "negative growth signal" that is "more powerful than the benefit of rate cuts being priced in." Put simply, if hiring continues to slow and unemployment drifts higher, the drag on earnings and economic growth will matter more for equities than the short-term lift from easing monetary policy.

Meanwhile, Apollo's Torsten Sløk flagged mounting job losses in tariff-hit sectors such as manufacturing, construction, retail, and transportation. Employment growth in these industries has now turned negative, according to Sløk's research, underscoring the added strain businesses face from trade policy uncertainty. (Disclosure: Yahoo Finance is owned by Apollo Global Management.)

Inflation could also complicate the outlook if the Fed begins cutting rates in a sticky price environment. Thursday's Consumer Price Index (CPI) will show how prices are trending.

Bloomberg consensus expects August's "core" CPI, which excludes volatile categories like food and energy, to rise 0.3% month over month and 3.1% year over year, keeping inflation firmly above the Fed's 2% target. Citi noted it would take a major upside surprise to derail next week's anticipated cut, but any signs of renewed price pressure could limit how aggressively the Fed eases from here.

And with the initial estimate of annual benchmark payroll revisions showing a downward revision of 911,000 — more than the 700,000 economists expected and close to the 900,000 some had projected — another red flag is emerging, suggesting the next test for markets may come sooner rather than later.

That leaves a key question for investors and policymakers alike: Will rate cuts be deep enough to counter mounting growth risks?

Morgan Stanley strategist Mike Wilson said equities' ability to absorb labor market weakness hinges on how forcefully the Fed responds.

With inflation still on the radar and jobs data weak but not "bad enough," he cautioned that the central bank may have limited room to ease in the near term, a setup that could mean "choppy" price action through a seasonally weak September and October.

Still, Wilson argued that any pullback would likely pave the way for a stronger finish to the year and into 2026, supported by what he sees as a durable, broad-based earnings recovery.

Goldman Sachs head of US equity strategy David Kostin, meanwhile, sees an even smoother path in the near term, noting that stocks typically rally during Fed cutting cycles so long as the economy avoids a recession, which he does not view as the base case.

He expects the S&P 500 (^GSPC) to climb to 6,600 by year-end, supported by renewed earnings growth in 2026, and sees room for a rebound in small caps stocks that have lagged under higher interest rates.

"As the economy moves through the worst of the tariff impacts, we expect imminent Fed rate cuts and a re-acceleration of growth in 2026 will support further gains for US equities," Kostin said.

Source : finance.yahoo

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Why a Fed rate cut might not help the stock market

Source : finance.yahoo

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