Market Now Expects Fed Interest Rate Cuts In The Second Half Of 2023, But That Could Be Bad News For Stocks

The consensus outlook for interest rates has shifted dramatically in the last month thanks in large part to the failures of U.S. banks SVB Financial Group, Signature Bank SBNY and Silvergate Capital Corp SI, as well as the emergency takeover of Credit Suisse Group AG CS by UBS Group AG UBS.

What Happened? Investors are now anticipating aggressive rate cuts by the Federal Reserve before the end of the year. The bond market is pricing in a 56.6% chance the Fed will cut interest rates by at least 0.75% by the end of 2023, up from a zero chance just one month ago.

Why It's Important: Rate cuts are typically good news for stock prices, and DataTrek Research co-founder Nicholas Colas said Monday that could certainly be the case in 2023 as well.

Colas said the bond market's recent shift in interest rate expectations could signal that investors believe the credit market disruptions will help alleviate the U.S. inflation problem, allowing the Fed to ease its monetary policy sooner than expected and navigate a "soft landing" for the U.S. economy.

Yet Colas said it's still too early to assume 2023 rate cuts are good news for stocks: it's possible that interest rate expectations are falling because investors are now anticipating a deep recession ahead.

"In that case, we can assume earnings will decline quickly… That would likely not be good for U.S. equity valuations," Colas said.

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Benzinga's Take: Given the SPDR S&P 500 ETF Trust SPY is flat in the last five days, Wall Street may actually be split on the reason the Fed may turn to cutting interest rates in the second half of the year. Investors will get another key inflation update on Friday when the Bureau of Economic Analysis releases its February personal consumption expenditures price index reading.

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