The Federal Reserve could do the opposite of raising interest rates in the future.
If there is a deep economic recession and corporate earnings plummet, that is what will happen.
The Fed is expected to raise its rate by 75 basis points later today. It would push the federal funds rate to a range of 3.0% to 3.25% by the end of the day, a far cry from its range at the start of the year.
According to current market expectations, the fed funds rate will be in a range of 4% to 4% by the end of the decade.
There is an ongoing risk that the Fed overtightens as it focuses on lagging indicators while economic growth slows. Jamie Dimon is going to testify to congress later today.
Americans are feeling the pain and consumer confidence is dropping. Even the best and brightest economists are split as to whether the storm clouds will evolve into a major economic storm or not.
Since December, the unemployment rate has remained below 4%, which is a key factor to watch. In August, the rate increased to 3.7% from 3.5% in July.
If the unemployment rate goes up, the decline in earnings could become more significant. According to the note, investors shouldn't ditch stocks because the Fed could come back to easing financial conditions.
In an adverse scenario, we believe that the Fed would be cutting rates by more than is currently priced in, thus stopping equity markets and inducing higher P/E Multiples.
The market is pricing in a Fed pause in interest rate hikes for most of the year, with two rate cuts coming towards the end of the year. If the economy begins to weaken, the rate cuts could accelerate considerably.
A potential markets-friendly Fed in 2023, along with low investor positioning and a decline in long-term inflation expectations, suggests that downside in the stock market is limited at current levels.