The Board of Governors of the U.S. Federal Reserve

Caution needed as markets to rally on Fed minutes

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Stock markets could experience a rally this week as investors look for clues on the US Federal Reserve’s policy path on interest rates, but caution is still required, said the CEO of financial advisory and fintech deVere Group.

Nigel Green’s bullish comments came ahead of the release of the Federal Open Market Committee (FOMC) May meeting minutes this week, from the branch of the US central bank responsible for implementing monetary policy.

“Investors will be delving into the minutes of the meeting to look for hints about whether the world’s most influential central bank will hike interest rates for the 11th consecutive time in June.

“Despite inflation remaining high, and continuing tightness in the labour market, there’s a growing sense that the Fed is now likely to pause its rate-hiking agenda next month,” said Green.

“Much of this optimism is down to Fed Chair Jerome Powell saying last Friday that stresses in the banking sector could mean that interest rates won’t have to be as high to control inflation.

“If this consensus gains momentum on the back of the FOMC minutes on Wednesday, markets will rally as it will appear that the end of rate hikes is getting closer and closer.

“However, should this happen, investors must remember this would not yet be a pivot, it would remain a hawkish pause.”

A rally, though, is “going to be tempered somewhat by worries about delays to finding a deal on the US debt ceiling crisis, which looks like it’s going to go down to the wire,” said Green.

Last week, the deVere boss had warned of the need to avoid complacency.

“While stock markets are enjoying a wave of buoyancy, with investors appearing to be looking beyond the current interest rate cycle and ahead to the next upswing in the economic cycle, core major bond markets continue to be marked by inverted yield curves, which suggest a recession is looming,” Green had said.

Recession ahead

“The inverted yield curve indicates a recession is ahead because it’s a sign of a tight credit market and weak economic growth. The inversion has preceded most US recessions – which, of course, have a huge drag on the global economy – since 1950.

“With this disconnect between stocks and bonds, investors should brace themselves for significant volatility in financial markets over the next few weeks. We could see a 10% correction.”

A potential Fed pause of rate hikes this week will have a positive impact on US stock markets, which will then likely boost global indexes for four primary reasons.

First, the slowdown in the increase of borrowing costs for businesses and individuals. Stable borrowing costs stimulate economic growth, increase consumer spending, and boost corporate profitability.

Second, a boost to investor confidence. Investors will perceive a pause in rate hikes as a sign that the economy is on a more stable path which, in turn, will lead to increased demand for stocks, driving up stock prices.

Third, the capital draw. Stable interest rates may encourage investors to seek higher returns in other investment options, such as stocks, pushing their prices higher.

The deVere CEO concluded that if the Fed minutes suggest a pause next month of rate rises, markets are likely to rally.

“But I would urge investors to remain vigilant to other issues that might impact a sustained upward movement at this time.”