Source: Barron's Author: Randall W Forsyth

The Dow Jones Industrial Average is currently close to a record high of 40,000 points, but looking at the global stock market, the Dow is only one of the record highs. Large technology stocks have driven the S&P 500 index and the Nasdaq Composite Index to reach new highs. The same is true for Korea's Kospi Index. Even the European Stoxx 600 Index and Japan's Nikkei 225 Index have reached new highs.

What a wonderful world, investors should also thank the US Federal Reserve and other central banks that are preparing to cut interest rates in the next few months. These major central banks all expect inflation to continue to fall without triggering a recession.

In addition to the Federal Reserve, the European Central Bank and the Bank of England also hinted that interest rates would be cut in the future. The Swiss central bank unexpectedly cut interest rates last week. Although the Bank of Japan has begun to raise interest rates, interest rates in Japan are still close to zero, the yen exchange rate is weak, and monetary policy is still relatively relaxed. Meanwhile, Latin America's major central banks, led by the Bank of Brazil and the Bank of Mexico, have already begun cutting interest rates, about a year earlier than the G-10.

Last week, the “Summary of Economic Forecasts” (Summary of Economic Forecasts) released by the Federal Open Market Committee (FOMCommittee) confirmed that the Federal Reserve continues to expect to cut interest rates three times before the end of this year, by 25 basis points each time, in line with the forecast of December last year. Currently, the futures market also expects the Federal Reserve to cut interest rates three times this year. Earlier this year, the futures market expected to cut interest rates six to seven times this year.

Even if the FOMC raised expectations for US economic growth and inflation in 2024 and lowered expectations for the unemployment rate, the FOMC still expects to cut interest rates three times before the end of this year. The FOMC currently predicts that the US GDP will grow by 2.1% this year, which is higher than the 1.4% estimate in December last year; the core PCE price index, which excludes food and energy prices, is expected to rise 2.6% year over year, higher than the 2.4% previously forecast; the US unemployment rate is expected to be 4.0% by the end of this year, lower than the 4.1% forecast previously estimated.

Federal Reserve Chairman Powell said that the higher-than-expected inflation data for the first two months of this year was a “bump” on the road to fighting inflation, and investors should not pay too much attention to these poor data. Powell pointed out that the Federal Reserve will relax monetary policy at a slower pace until it is convinced that inflation is falling steadily towards 2%.

Mizuho Securities (Mizuho Securities) economists Steven Ricchiuto (Steven Ricchiuto) and Alex Pelle (Alex Pelle) wrote in a report to clients: “The Fed really wants to cut interest rates. The question now is no longer whether the Fed will cut interest rates, but when to start cutting interest rates.”

According to the CME Federal Reserve Watch (FedWatch) tool, the probability that the Fed will cut interest rates in June is about 75%.

Retscht and Pell also pointed out that the FOMC's increase in expectations for economic growth and core inflation lowered the threshold for the Federal Reserve to cut interest rates, while boosting investors' interest in risky assets (especially stocks). Interest rate cuts will have an impact on the real economy. They said, “The more relaxed the financial environment, the more likely it is that the economy will grow unexpectedly, and the labor market supply will be tighter.”

The Evercore ISI economic research team led by Ed Hyman (Ed Hyman) pointed out that the S&P 500 index rose 33% from a year ago, and housing prices rose 6% from a year ago. From this, it can be calculated that the net assets of US consumers in the first quarter of this year are expected to increase 9% compared to a year ago. Evercore ISI's survey of real estate agents also showed a strong rise in housing prices. Evercore ISI wrote in a report to clients: “It is rare for the US economy to begin a recession with such a strong rise in housing prices.”

While financial markets are booming and the credit-sensitive real estate market remains strong, the Federal Reserve still sees a need to relax monetary policy. Powell hinted at a press conference after the FOMC meeting that the current financial environment is tight. Jonas Goltermann (Jonas Goltermann), Deputy Chief Market Economist at Capital Economics (Capital Economics), wrote in the research report that Powell's opinion may be based on the relatively high real interest rates of the entire US Treasury bond market.

Goltman said, “The rise in the stock market and the general reduction in risk premiums indicate that this is not the case.”

edit/lambor