Investing.com – Recently exuberant equity markets could turn more cautious should the Federal Reserve restart policy easing as expected this week, according to analysts at JPMorgan Chase.
Investors appear to be using the potential borrowing cost reductions as a reason to “look through” a recent crop of soft U.S. labor market data, the analysts noted. The major U.S. indices have been hovering around record highs, with the tech-heavy Nasdaq Composite in particular notching a new all-time closing high on Friday.
“But the risk is that this changes,” they wrote. “Once the easing resumes, equities could turn more cautious for a bit, and price in some more downside risk, in effect repricing the current, potentially complacent, stance.”
In a note to clients, the analysts led by Mislav Matejka flagged that overall indices have historically tended to consolidate when the U.S. central bank resumes a cycle of rate cuts, adding that stocks then “stall[ed] for a few months, and would advance therafter.”
Traders are now all but certain that the central bank will slash interest rates at the end of its latest two-day gathering on Wednesday.
Underpinned by the signs of a weakening U.S. labor market, policymakers are widely anticipated to back the first rate cut since pausing a cycle of drawdowns in December. Lowering rates can, in theory, help spur investment and hiring.
However, a reduction can risk pushing up inflationary pressures at the same time. Last week, a monthly U.S. consumer price index reading accelerated slightly due to an uptick in housing and food costs, a potential indication of sticky inflation.
Yet a separate gauge displaying a rise in weekly initial jobless claims likely kept a Fed rate cut on track. There is now a roughly 95% probability that borrowing costs are lowered by 25 basis points, as well as about a 5% chance of a deeper half-point drawdown, according to CME’s FedWatch Tool. The Fed’s target rate currently stands at a range of 4.25% to 4.5%.
Against this backdrop, the JPMorgan analysts stood behind their “bullish view” on emerging market stocks, calling them “underowned” and trading at “attractive” valuations. The “worst” of trade-related uncertainty has also now passed, they added.
On a sector level, the analysts highlighted mining equities as a segment that will “perform better” thanks in part to a “stronger outlook” in China.
They also reiterated their backing for long-duration government bonds and suggested that a July-to-August stabilization in the U.S. dollar “might not last.” The dollar index, which tracks the greenback against a basket of rival currencies, is projected to slide 4%-5% over the next six months.