Biggest Q2 risk for S&P 500? Fed needing (not just wanting) to cut rates

US stocks traded mostly higher on Wednesday, following Federal Reserve Chairman Jerome Powell’s comments that three interest rate cuts are likely coming in 2024. Despite positive remarks, strategists at Bank of America warned that the Fed needing, not just wanting to reduce rates remains the biggest risk in Q2 for the S&P 500.

Powell’s comments fuel the S&P 500 rally

Federal Reserve Chair Jerome Powell said this week that recent spikes in inflation do not “change the overall picture,” hinting that the central bank remains poised to reduce its key interest rate three times this year if price increases continue to ease as anticipated.

“The recent data do not, however, materially change the overall picture, which continues to be one of solid growth, a strong but rebalancing labor market, and inflation moving down toward 2% on a sometimes bubbly path,” Powell said during his speech at a forum at the Stanford Graduate School of Business.

Powell’s remarks came a day after new economic data showed that job vacancies remained stable at 8.8 million in February. This figure is below the peak of 12.2 million seen in early 2022 though still above the pre-pandemic average of approximately 7 million.

US stocks staged a volatile session on Wednesday, though remained higher in the wake of Powell’s speech. Still, the first quarter, which ended last week, was the best for the S&P 500 in five years.

Powell added that a strong US economy means that the policymakers can comfortably remain on hold while awaiting more data. However, cutting interest rates too soon could lead to an uptick in inflation, he cautioned.

Fed is still the biggest risk – BofA

In their weekly “Flow Show” report detailing fund flows across various asset classes, Bank of America strategists also touched upon the Fed’s monetary policy path.

In particular, the strategists believe a decline in US payrolls during a period when the cost of living is high represents the “biggest Q2 tactical risk” to the ongoing “ABB” (Anything But Bonds) bull market, suggesting that “Fed needs, and not just wants, to cut rates.”

The investors’ “strike” against buying government bonds is highlighted as a significant force driving remarkable performance across various markets, BofA said.

This includes a 40-year equity high in Japanese stocks, a 20-year high in European stocks, record levels in the U.S. markets, as well as strong performance in commodities and cryptocurrencies.

Per data from Fed funds futures trading, markets believe there’s almost a 90% chance that the Federal Reserve will keep interest rates steady in its May policy meeting.

Furthermore, data also shows there’s a 57.2% likelihood of a rate reduction at the June meeting, down from 70.1% just a week earlier.

Despite this, Citibank economists view risks “as balanced toward more rate cuts this year, not fewer,” they said earlier in the week.

“0.26% core PCE and Chair Powell’s comments suggesting the Fed is on-track for cuts are more important than ISM manufacturing barely above 50.0. The Fed reaction function now places a larger weight on labor market data and we see downside risk to Friday’s jobs report, projecting a 150k increase in payrolls,” they wrote.