Investing.com — The Federal Reserve's decision to cut interest rates by 50 basis points has sent markets into a tailspin, but many are wondering what this expected shift to a dovish stance means beyond the short-term reaction.
The Fed's decision on September 19 was widely expected, with the central bank also pledging another 50 basis points of rate cuts before the end of the year. This initially triggered a rally, which took markets to new all-time highs before a “sell the news” reaction sent markets slightly lower at the end of the day.
In the short term, this dovish stance has left markets in a generally constructive position. The main risk factors remain potential negative economic data, but the current economic calendar is light until early October.
Without the threat of significant earnings reports or major economic releases, investors appear to be operating in an environment that is “1) an expansionary Fed, 2) slowing but 'acceptable' economic data and 3) generally solid earnings,” Sevens Report said in a recent note.
Cyclical sectors, including energy, materials, consumer discretionary and industrials, are expected to outperform, while technology may lag in the near term.
The long-term implications of the Fed's decision may be more complex, however. The key question for investors is whether the Fed acted in time to prevent a broader economic slowdown.
According to the Sevens Report, if rate cuts come at the right time, they could lead to falling yields, strong earnings growth and positive economic tailwinds. This would likely result in continued bullish momentum for stocks, with the potential for the S&P 500 to reach 6,000 points.
“I say this with confidence because the Fed’s shortening of the maturities would generate this macroeconomic outcome: 1) falling yields, 2) very strong and continued earnings growth, 3) positive economic tailwinds, 4) the prominent existence of the Fed put option, and 5) expectations of an acceleration of growth in the future,” wrote the president of Sevens Report in the note.
On the other hand, if the Fed's actions come too late to prevent an economic recession, the market could face significant risks.
In such a scenario, the S&P 500 could fall to around 3,675, which would mark a sharp decline of more than 30% from current levels. This downside risk reflects market corrections seen in previous recessions, such as those in 2000 and 2007.
As markets digest the Fed's moves, future economic data will be crucial in determining whether the central bank's policy was effective.
More specifically, investors will need to keep a close eye on upcoming releases to gauge whether the Fed has managed to pull the economy out of a recession or whether more challenges lie ahead.
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