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Stock Market Bulls Made a Fool’s Gamble on Rate Cuts

Last Updated March 4, 2021 2:37 PM
Ryan Smith
Last Updated March 4, 2021 2:37 PM

When US nonfarm payrolls stunned traders by rising dramatically on Friday, the stock market’s bet that the Fed would stimulate further growth by drastically slashing interest rates was exposed as a fool’s gamble.

That’s according to economist Mohamed El-Erian, who explained to CNBC’s “The Exchange” that a rate cut in July was likely but 50 basis points was probably out of the question:

“I think you’re going to get a 25 basis-point cut. I think putting it as an insurance rate cut is the right way. The economy is not in trouble. Today’s employment report is actually very good news for the economy…”

As CCN.com reported, the labor market added 224,000 jobs in June smashing through the widely expected 165,000 figure. While some players are hoping for three cuts come year-end, El-Erian predicts the Fed will only have the stomach for two, if that.

As the longest expansion in US history continues, economists seem divided on the overall health of the economy. While El-Erian remains bullish, others have been calling for a recession which is long overdue. Non-labor-market data remains weak. ISM manufacturing, for example, recorded its lowest reading since 2016.

Jobs Numbers Give Stock Market Bulls Food For Thought

Fed officials indicated last year that a rate cut in 2019 was unlikely. Most pundits, however, are pricing in a near 100% chance of a cut by end of July despite Friday’s strong numbers. As usual, President Trump was quick to talk up the numbers and consequently also bash the Fed.

In a separate interview  with CNBC, economist, and founder of Dynamic Economic Strategy John Silvia, echoed El-Erian’s sentiments calling for a measured approach. When asked what would happen if the Fed didn’t cut rates this year, Silvia explained:

“Well I think the market will be really upset in terms of valuations. People will be asking why aren’t they cutting. It doesn’t appear that the overall economy is picking up.”

Second Quarter Earnings Just Around the Corner

Mohamed El-Erian, stock market
Economist Mohamed El-Erian warns that Wall Street is far too optimistic about the Fed’s rate cut policy. | Source: World Economic Forum/Flickr

Still, investors may want to hang on to their hats before reversing course on these latest numbers. Q2 earnings will start pouring in a few weeks from now. Those numbers should give market participants a much clearer picture of the US economy overall. As CCN.com recently reported, Q2 guidance is looking nothing short of catastrophic.

Indices, nevertheless, continue to press their upper limits. The most likely culprit? A whirlwind of corporate stock buybacks propping up equities even as profits lag. Investors will have to wade through a difficult investing climate given all the mixed signals.

Stock Market Holding Firm Near All-Time Highs

Most indices closed marginally lower on Friday thanks to mid-morning buying after sharp losses at the open. The Dow Jones Industrial Average (DJIA) fell 43.88 points, or 0.16%, to finish the session at 26,925.609.

Dow Jones Industrial Average July 5. Stock market naive
The Dow Jones Industrial Average finished flat on the day after recovering losses. | Source: Yahoo Finance 

The Federal Open Market Committee (FOMC) is scheduled to meet on July 30 and 31 leaving investors with a packed July calendar to contemplate. El-Erian’s prediction, conservative as it is, may not even unfold.

The Fed’s rate cut watch tool currently sits at 95%, but there’s nothing stopping the central bank from playing a different hand. Or no hand at all. It wouldn’t be the first time.