Why A Fed Pause Might Not Be Good News For Stocks

Why A Fed Pause Might Not Be Good News For Stocks
Stéphane Renevier, CFA

7 months ago1 min

With US inflation falling for a tenth-straight month after an aggressive run of interest rate hikes, it’s looking more and more like the Federal Reserve’s (the Fed’s) next move might be a pause. That means no more rate hikes, but also no rate cuts, at least until the data changes significantly.

The good news is that, historically, a Fed pause has on average been positive for stocks. The bad news is that the feel-good effect disappears when the yield curve is inverted. Today, the curve is not only inverted, but the macroeconomic picture is also looking very grim.

Morgan Stanley identified five “good pauses” from Fed history: 1985, 1995, 1997, 2006, and 2018. And they’ve got one thing in common: the economy was in a pretty good shape when the Fed put the brakes on: industrial production (IP) was growing, leading indicators (LEI) were pointing at strong growth ahead, unemployment was high enough to guard against an inflationary spike, core CPI inflation was mild, the yield curve (from the US two-year Treasury to the ten-year Treasury) was upward sloping, and banks were easing their lending standards (SLOS).

Today couldn’t look more different: industrial production is stagnating, leading indicators have collapsed, there’s no buffer in unemployment, core inflation’s uncomfortably hot, the yield curve is sharply inverted, and banks are tightening their lending standards significantly. That suggests one of two things: either this pause is unlikely to be “good” for stocks, or the Fed won’t pause at all, and might be forced to cut interest rates to prevent a sharp recession. Consider yourself warned before interpreting a Fed pause as a bullish sign...



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