Investors on edge ahead of US rates call amid global uncertainty

All eyes are on the Federal Reserve’s upcoming interest rate decision, but investors may be too optimistic over the prospect of US policymakers showing a greater willingness to cut.

Traders work on the floor of the New York Stock Exchange. Picture: Angela Weiss/AFP

The US Federal Reserve is widely expected to keep interest rates on hold as the central bank assessed the impact of rapidly rising US tariffs.

Interestingly, though, markets expect Federal Open Market Committee members to shave their interest rate projection.

Whereas that could satisfy the market’s need for a “Fed put” after the S&P 500 fell as much as 10 per cent from its record high in recent weeks as tech giants dived, it’s fairly clear that unchanged interest rate projections would disappoint the market, sparking a renewed sell-off in stocks.

There’s been no panic yet in markets, but the FOMC’s upcoming meeting could be a litmus test that may shake the market’s cool, according to Barclays. And while institutions were already reducing equity exposure prior to the sell-off, it has been a different story for retail investors.

“Global macro hedge funds were close to neutral on equities heading into February and are now seeing slight dip buying, while long-only funds were also heading to neutral and are now below their long-term median,” said Barclay’s global head of derivatives strategy, Anshul Gupta.

“Retail, on the other hand, poured about $US380bn (603bn) into global equities over the past six months, with over 65 per cent allocated to the US.

“With nearly half of all household assets tied up in equities and sentiment at bearish extremes, retail outflows from US equities have started to pick up over the past two weeks, fuelling a rotation into European and APAC-DM equities.

“However, we are of the view that retail investors have in no way capitulated.”

Federal Reserve chair Jerome Powell. Picture: Alex Wong/AFP

Mr Gupta said institutional investors have “meaningfully cut back on equities amid historically stretched policy uncertainty, growth concerns, and diminishing US exceptionalism.”

It came as BofA’s Global fund manager survey for March saw the second-biggest drop in global growth expectations ever, the biggest drop in US equity allocation ever, the biggest jump in cash allocation since March 2020.

“Stagflation, trade war, end of US exceptionalism drive ‘bull crash’ in sentiment, the speed of which is consistent with the “end of equity correction”, BofA’s chief investment strategist, Michael Hartnett, said.

“That said, no one is long recession/bonds, FMS positioning nowhere near extreme bear/close-your-eyes-and-buy levels.”

On that note, Barclays said retail participation in stocks, “while subsiding, remains historically elevated, as evidenced by the Barclays Equity Euphoria Indicator.”

“Importantly, this may be due to markets’ faith into the ‘Fed put’, which crucially could be put to test this week at the FOMC meeting, solicited, for instance, by a more hawkish than expected Fed, as inflation progress disappoints,” said Barclays’ Mr Gupta.

Economists surveyed by Bloomberg see the median projection of the midpoint of the Fed funds rate target range falling to 3.5 per cent for 2025 and 3.125 per cent for 2026, well below the December projections of 3.875 per cent and 3.375 per cent respectively.

The money market projects smaller falls to 3.73 per cent for 2025 and 3.45 per cent for 2026.

However, it’s fair to say that the stock market had priced in some lowering of the “dot plot.”

There’s something of contradiction here – if the FOMC is concerned about “maximum employment” more than “price stability” at this point, it should cut interest rates at this meeting.

Part of the reason why the FOMC sat on its hands in January rather than keep “normalising” interest rates, was to assess Trump administration policies, much of which look to be inflationary.

No doubt, the US economic data have stopped surprisingly positively in the past few weeks. But much of that correlates to the preceding rise in US Treasury yields, which has substantially reversed.

Survey-based US economic data have fallen sharply.

Traders work on the floor of the New York Stock Exchange, Picture: Angela Weiss/AFP

Atlanta Fed now predicts a 1.76 per cent annualised fall in March quarter US economic growth. However, US employment growth and core retail sales continue to hold up fairly well.

Meanwhile, core inflation definitely remains “sticky” near 2.6 per cent versus the 2 per cent target.

If the FOMC now indicates that rates will fall even faster than expected in December – despite the massive rise in US tariffs now underway – it would give the wrong message to the bond market.

It would suggest the Fed is prepared to underwrite a drop in demand caused by tariffs, encouraging businesses to pass on price increases and lift wage rates well above inflation.

Of course, FOMC members often change their interest rate projections and don’t have to follow through, so perhaps they will see this as a riskless way to head off a potential bear market.

Some forecasters are quite bearish on the labour market and think the Fed should start cutting rates again in May, versus the consensus that rate cuts will resume in July.

“Stubborn inflation in January and February and the rise in inflation expectations limits the extent of the dovish move and rates will likely stay on-hold at this meeting,” said Citi’s chief US economist, Andrew Hollenhorst. “By the May FOMC meeting, officials will likely conclude that downside growth risks predominate and begin a new series of rate cuts.”

Mr Hollenhorst expects the “dot-plot” to project 75 basis points of Fed rate cuts in 2025 versus 50bps that was projected in December. But Bloomberg’s survey sees 85 basis points being projected.

But Goldman Sachs said FOMC participants should actually be rethinking their expectations of interest rate cuts now that the first tariffs have taken effect and the White House looks set to eventually impose larger tariffs than initially seemed likely.

“Both elevated policy uncertainty and the likelihood of higher tariffs and higher inflation this year mean that the normalisation cuts that FOMC participants pencilled into the dot plot at the end of last year now look further off,” said Goldman Sachs chief US economist, David Mericle.

“But we suspect that the Fed leadership would nevertheless prefer for the median 2025 dot to continue to show two cuts this year to avoid adding to recent market turbulence, even if this might be somewhat awkward to explain as a modal forecast.”

Originally published as Investors on edge ahead of US rates call amid global uncertainty