Even With Big Tech Stocks, The Stock Market Believes The Fed Will Cut Rates Soon. It Just May Be Right.

The stock market has recently been chilled even with Big Tech stocks moving up despite the normal impact of rising interest rates. People who believe the present rise will not persist are overlooking that it indicates that interest rates will decrease shortly.

The S&P 500 has risen almost 20% since its bear-market bottom in early October. A large portion of the recent rise has come from Big Tech stocks, which are profiting from the introduction of artificial intelligence.

Even before that, investors were hopeful that the Federal Reserve would soon stop raising interest rates due to slowing inflation and economic growth. A temporary halt to rate hikes would aid in the stabilization of economic growth, resulting in higher business earnings and stock prices.

As investors anticipate calmer market conditions, the Cboe Volatility Index (VIX), a measure of predicted stock-price volatility known as Wall Street’s fear gauge, has declined from a high of nearly 32 in October to around 13. It is getting close to its lowest point since shortly before the March 2020 lockdowns.

The bond market reflects a more pessimistic outlook. The MOVE Index, which gauges bond market volatility, is now at 115, down somewhat in recent months but still significantly above its record low of 36 set in late 2020. With the decrease in stock market volatility, it has not declined in lockstep, suggesting anxiety that the Fed’s ten interest-rate hikes beginning in March 2022 will wreak even more devastation on the economy.

The tighter monetary policy generally has a delayed effect on the economy. Borrowing costs are high since the Fed’s objective for the fed-funds rate is 5%-5.5%.  

That is why many people are increasingly skeptical of the stock market. The S&P 500 is currently trading at an expensive level, putting it in danger, especially when safe Treasury paper is yielding much more than it used to, prompting some to question how anybody can continue to purchase equities at these levels. And, without a doubt, the stock market might correct if a recession proves to be more challenging than expected for corporate earnings, a scenario that could drive money into bonds.

“It’s now time for a bit of a tree shaking to wring out some of the complacency that everything will be just fine notwithstanding tight money, quantitative tightening, and the various economic challenges that will not change for a while,” wrote Peter Boockvar, chief investment officer at Bleakley Advisory Group. 

However, there is a pattern to the stock market’s reasoning.

One of the most plausible causes for the stock market’s calm is that investors are expecting lower interest rates. Given that inflation has been cut in half in approximately a year, there is a potential that the Fed may drop rates later this year. Easier monetary policy may aid the Fed in steering the economy toward a smooth landing.

Even if no cuts are imminent, a halt in rate rises might lower the 2-year Treasury yield, making equities more tempting.

It is not the first time the stock market has calmed while the bond market erupted. According to RBC, there were several months between the 2008-2009 financial crisis and the pandemic when the stock market was quiet, but the bond market was tumultuous.

“It’s not unusual for the VIX to fall before MOVE,” wrote Lori Calvasina, chief U.S. equity strategist at the firm. 

When a stock market surge seems impossible to believe, check into the reasons. There might be a message in there somewhere.