Rate cuts could spell trouble for stocks, economist warns

Wall Street is eagerly waiting for a Fed rate cut, but one analyst says investors should be careful what they wish for.

According to Bank of America strategist Michael Hartnett, a rate cut could be the "first hint of trouble" in the economy, which would, in turn, stoke fears of a "hard landing."

(A hard landing is a period of rapid growth followed by a prolonged downturn.)

In a note, Hartnett urged investors to be prepared to buy dips in bonds at every opportunity and sell stocks the moment the Fed begins lowering interest rates.

Hartnett says he is paying close attention to cyclical stocks, which tend to follow economic cycles by rising in value during periods of expansion and declining during a recession.

The analyst believes that—if these stocks don't go up after a rate cut—the market could be spooked into thinking that a slowdown is on the horizon.

Good examples of cyclical stocks include airlines and luxury goods manufacturers, primarily because they tend to see an uptick in demand when the economy picks up.

A tale of two continents

Over in Frankfurt, the European Central Bank took the plunge and slashed rates by a quarter point last Thursday, the first reduction in five years.

But as Creditnews reported, analysts believe the ECB "boxed themselves into a corner" by conditioning the market for lower interest rates in an economy that is still highly inflationary.

The Bank of England is widely expected to follow suit this summer when it meets on June 20 or August 1, but the Fed's timing remains quite uncertain on the back of surprisingly strong jobs numbers.

A total of 272,000 roles were added in the U.S. last month—far, far beyond analyst expectations of 185,000 hires.

All eyes now are on inflation data for May, which is set to be released on Wednesday and will undoubtedly inform Jerome Powell's thinking.

That same day, the Federal Reserve will give an update on the closely watched "dot plot," offering a glimpse into where policymakers think rates are headed in the months and years to come.

A Bloomberg survey suggests economists are divided on whether it'll signal two 0.25% cuts between now and the end of 2024—or potentially none at all.

In a recent op-ed, ING's chief international economist, James Knightley, argued that there is "broadening evidence" that the Fed can start cutting interest rates sooner rather than later.

"If we get the combination of cooler inflation, a looser jobs market, and stalling consumer spending growth, we believe the Fed will indeed look to move monetary policy from 'restrictive' to 'slightly less restrictive,'" he wrote.

He predicts "[quarter point] rate cuts at the September, November, and December FOMC meetings."