Fed Will Save Markets With Rate Cuts If Recession Occurs

  • According to JPMorgan, the Federal Reserve could be forced to cut interest rates in 2023 if there is a deep recession.
  • The move would be a U-turn for the Fed considering it aggressively hiked rates in 2022.
  • Potential Fed rate cuts would help support the stock market in the event of a steep decline, said JPMorgan’s Marko Kolanovic.

Just as quickly as the Federal Reserve hiked rates in 2022, it could do the exact opposite and cut rates in 2023, according to JPMorgan.

That’s when a deep economic recession hits and corporate earnings plummet, JPMorgan’s Marko Kolanovic said in a statement on Wednesday.

The Fed has been on an aggressive rate hike path so far this year, with another outsized hike of 75 basis points expected later today. That would push the federal funds rate down to a 3.0% to 3.25% range by the end of today, a far cry from its 0% to 0.25% range at the start of the year.

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By the end of 2022, current market expectations suggest that the Fed Funds Rate will be in a 4% to 4.25% range as Fed Chair Jerome Powell attempts to erase high inflation readings.

But rate hikes take time to flow through the economy, meaning there is an ongoing risk that the Fed will over-tighten as it focuses on lagging indicators while economic growth slows. None of this escapes JPMorgan CEO Jamie Dimon, who is due to testify before Congress today.

“Many Americans are feeling the pain, and consumer confidence continues to fall. As these storm clouds gather on the horizon, even the best and brightest economists are divided on whether this could turn into a major economic storm or something much less severe,” Dimon said in prepared testimony.

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A key factor to watch is whether the unemployment rate will start to rise as it has remained steady below the 4% mark since December. The rate recently rose to 3.7% in August from 3.5% in July.

“The fall in income could become more pronounced if the unemployment rate rises significantly and a protracted or deep recession occurs,” Kolanovic said. However, such a scenario does not mean that investors should dump stocks as the Fed could return to its years-long practice of easing financial conditions, according to the release.

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“But even in this unfavorable scenario, we believe the Fed would cut rates by more than what’s currently priced in for 2023, dragging equity markets and inducing higher P/E ratios,” he added.

The market is currently pricing in a pause in interest rate hikes by the Fed for most of 2023, with two potential 25 basis point rate cuts towards the end of next year. Finally, Kolanovic believes these rate cuts could accelerate significantly if economic strength begins to deteriorate.

A potentially market-friendly Fed in 2023, combined with low investor positioning and a decline in long-term inflation expectations, suggests that stock market downside is limited at current levels, even if a slowdown materializes next year, Kolanovic concluded.

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