Investing.com -- The Federal Reserve, led by Chairman Jerome Powell, is set to decide on September 18th whether to lower interest rates.
The central bank has hinted that the U.S. economy might achieve a "soft landing," meaning inflation will decrease without causing a severe economic slowdown.
However, analysts at BCA Research in a note dated Monday question this optimism, arguing that the economy is still facing challenges.
“Investor sentiment is highly positive, with little cash on the sidelines, and US equities trading at 21x (very optimistic) forward earnings expectations,” the analysts said. This bullish outlook reflects confidence in the Fed’s ability to manage the economy without causing a recession.
Both individual and institutional investors are fully invested in the equity markets, leaving minimal cash on the sidelines. As per analysts at BCA, such extreme optimism is often followed by market corrections, particularly if economic conditions begin to deteriorate.
Historically, stock markets have often seen a decline after the Federal Reserve's first rate cut in a cycle. This pattern has been observed in past instances, such as in 2001 and 2007.
An exception was 1995, when the Fed successfully cut rates without causing a recession. However, today's economic conditions are markedly different from those of the mid-1990s.
Unemployment is on the rise, and the job market is showing signs of weakness. This is supported by the Sahm rule, which was triggered last month, suggesting a potential recession is looming.
Analysts at BCA paint a bleak picture of the labor market. Job creation has plummeted by over a million in the last two years, and revised nonfarm payroll data reveals that job growth has been exaggerated.
Although unemployment claims haven't skyrocketed, the overall trend indicates a weakening labor market. This decline raises concerns about the long-term viability of the economic expansion and the Fed's ability to achieve a gradual slowdown.
Even if the Fed proceeds with rate cuts as anticipated, monetary policy will remain restrictive for some time. BCA analysts warn that the benefits of easier monetary policy may not materialize quickly enough to avert a downturn.
The lag between rate cuts and their impact on the economy, which typically spans about 12 months, means that the economy could still face significant challenges even after the Fed begins to ease policy.
BCA Research suggests investors to be cautious with their portfolios due to current economic risks. They recommend holding fewer stocks and bonds, preferring government bonds as a safer bet in case of a recession.
Within stocks, they favor defensive sectors like consumer staples, healthcare, and utilities, which are less likely to be affected by a downturn. While they slightly prefer U.S. stocks, they warn that tech stocks could drop in value if the economy gets worse.