After Fed rate cut, the next 6 months will be crucial for investors. Here's why.

By Joy Wiltermuth

'There still are opportunities here,' says Erik Aarts at Touchstone Investments

The Federal Reserve hit the ground running on Wednesday with a big rate cut to kick off its easing cycle, signaling its seriousness about wanting to fend off any further deterioration in the labor market.

The Fed's first rate cut lopped 50 basis points off its policy rate, bringing it down to a range of 4.75%to 5%. While that was a bold move, it also leaves short-term rates relatively high.

That gives the central bank and investors more time to brace for what comes next.

"Our call, as a committee, is that we are going to see a soft landing," Erik Aarts, a senior fixed-income strategist at Touchstone Investments, told MarketWatch. But the rates market is still trying to figure out what happens going forward, he said.

"The old adage about buying the rumor and selling the news, I think we are going to see a little of that," Aarts said. While he expects a choppy next six months, he also anticipates buying opportunities, particularly if the 2-year BX:TMUBMUSD02Y and 10-year Treasury yields BX:TMUBMUSD10Y keeping bumping up from recent lows.

"If you haven't locked in yields, you get a chance to do that here," Aarts said. "Interest rates and bonds still are at levels that are attractive to investors who may have been waiting for this first rate cut to act."

The path of interest rates, however, isn't very clear when looking at past rate-cutting cycles since the mid-1990s, or when looking at what Wall Street has priced into markets.

"Remarkably, we enter this impending cycle with the market priced for significantly more easing than was the case for each of the past 6 episodes," a team of BofA Global rates and currency strategists wrote in a Thursday client note.

Fed-fund futures recently implied that short-term rates would tumble by nearly 2%.

Yet that also has fluctuated from 2% to 4.5%, a "pretty wide range of outcomes," since the Fed started raising rates in 2022, according to Apollo Global Management's chief economist Torsten Slok. The "market narrative at any point in time is almost always wrong," he said in a Thursday client note.

Moreover, investors looking to the past for guidance on the future could be grasping at straws. The BofA Global team thinks this easing cycle has no close relevance to recent ones, not even the 1995 "soft landing" scenario that investors and the Fed hope to replicate.

Pricing action in markets over the past week underscores how difficult it can be to accurately predict the path of rates, with longer-term rates pushing higher even as the Fed cut short-term rates.

The 10-year Treasury yield BX:TMUBMUSD10Y has been climbing since the Fed cut rates on Wednesday. It was trading at 3.73% on Thursday, after touching a new one-year low of 3.62% earlier this week, a level associated with a recessionary backdrop.

Related: Bond market gets a Fed wake-up call after pricing in a recession

Gennadiy Goldberg, head of U.S. rates strategy at TD Securities, said in a Thursday client note that he would look to be a buyer in any significant moves higher in rates. He still expects 10-year yields to end the year at 3.5% but for the path lower to be a "grind."

While the bond market lately has played a big role in driving the action in stocks, both the Dow Jones Industrial Average DJIA and S&P 500 SPX were trading in record territory Thursday, appearing to shake off any earlier reservations about the Fed's big first rate cut.

Clearly, the trajectory of the labor market will loom large in terms of informing the Fed's next steps on interest rates. Fresh data Thursday showed the number of Americans who applied for unemployment benefits dropped to the lowest level since May.

Stock performance in the wake of previous Fed rate-cutting cycles has been mixed, with the economy being the deciding factor in whether investors see sharp losses or gains in equities.

See: A Fed rate cut with the stock market at a record high? Here's what history says.

The Fed, meanwhile, has been "trying to catch the labor market," Touchstone's Aarts said. He thinks the next six months should help clarify for investors whether it has done that job or not.

-Joy Wiltermuth

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09-19-24 1331ET

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