After the U.S. Federal Reserve left its key interest rate unchanged at 5.25% last week and dropped language suggesting the possibility of rate increases ahead, Wall Street rallied.
When Fed chairman Ben Bernanke signalled on Wednesday that he plans to hold rates steady, investors seem to read the comments as an indication that a rate cut was less likely. Markets fell.
So while speculation about the Fed’s direction may be quieting, Vincent Delisle thinks the debate about the timing of pending rate cuts is not.
The Scotia Capital analyst notes that getting the Fed to cut rates is less important than a soft landing for the economy.
He also says markets are range-bound in the six months preceding the first rate cut. Twelve months after an initial rate cut, average equity gains prove to be modest for the S&P 500 at 7.3% and nearly flat for the TSX.
“The catalyst to a sustainable rally comes from the bond market when the yield curves steepens and turns positive,” Mr. Delisle said in a note to clients.
He thinks the risk for markets is a prolonged period of stable rates, such as if they remain at 5.25% for an entire year.
But it is indeed all about the landing in Mr. Delisle’s opinon.
When the U.S. economy lands hard, the average S&P 500 performance is a 5% gain 12 months after the first interest rate cut. For soft landings, that number is 14%.