Rate cut hopes may bolster U.S. stocks as investors await earnings, elections

Investors anticipate Fed rate cuts to boost stock market, but potential risks loom amid political uncertainty and earnings reports.

The prospect of near-term interest rate cuts is bolstering the case for investors to remain bullish after a run in U.S. stocks that may soon be tested by upcoming corporate earnings reports and growing political uncertainty. Expectations that the Federal Reserve will kick off its long-awaited rate-cutting cycle in September remained firm on Tuesday after Fed Chair Jerome Powell told Congress that the U.S. is “no longer an overheated economy,” suggesting that the case for easing monetary policy is growing stronger.

Rate-cut bets have fluctuated sharply throughout the year and have been only one of several factors—along with strong earnings and excitement over artificial intelligence—that have helped the S&P 500 rise about 17% year-to-date. Still, many investors believe increased clarity on when the Fed will begin easing monetary policy and how much it might lower rates in 2024 could provide a buffer to stocks if markets grow turbulent in coming months.

The beginning of rate cuts will signal that “the Fed has the market’s back,” said Yung-Yu Ma, chief investment officer at BMO Wealth Management. He expects the central bank to cut rates about six times over the next year. “We think that’s definitely a positive factor both for the markets and the economy,” he said.

Investors late on Tuesday were factoring in an over 70% chance that the Fed will cut rates in September, compared with roughly 50% a month ago, according to CME FedWatch. Fund funds futures are pricing in about 50 basis points of easing in 2024 overall, according to LSEG data.

“The Fed is getting closer to a rate cut,” said Peter Cardillo, chief market economist at Spartan Capital Securities. “I believe we’ll see a rate cut in September and another one in December.”

Mr. Powell told the Senate Banking Committee that inflation had been improving in recent months and that “more good data would strengthen” the case for looser monetary policy.

One early test comes on Thursday, with the release of U.S. consumer price data for June. While the last several reports have shown that inflation is starting to cool, a stronger-than-expected number could undermine the case for easing in coming months.