3 things the Fed needs to stick a soft landing

As of Friday afternoon, investors are pricing in a 59% chance of a 50-basis-point interest rate cut from the Federal Reserve at its September meeting next week. John Hancock Investment Management co-chief investment strategist Matt Miskin joins Market Domination to discuss the rate cut path ahead and how it may impact the broader market (^DJI,^GSPC, ^IXIC).

Miskin expects the Fed to initiate a 25-basis-point rate cut and announce more cuts to come. He points to three things the Fed needs to do to secure its soft landing. The first is by cutting rates aggressively and significantly lowering the fed funds rate. Second, the labor market needs to remain calm, so initial jobless claims must stay low and the unemployment rate cannot rise. Finally, high-yield spreads must stay tight.

"You have those three things over the course of a week like this, and markets love it. You saw the two-year yields fall a lot. You saw the dollar fall a lot. That's going to help actually borrowing costs. It helps foreign revenues. So that actually was pricing in a lot more of that soft landing scenario," he explains.

As the Fed kicks off its rate-easing cycle, Miskin believes that the market's outlook depends on whether or not the US heads into a recession. He notes that historically, when the Fed eases rates and a recession does not occur, stocks rally. On the other hand, stocks will likely come under pressure, while bonds will stand out if there is a recession. In both scenarios, the defensive areas of the market usually take leadership, so investors should take advantage of these historical patterns.

Meanwhile, gold (GC=F) has surged to another record high, which Miskin believes sends a mixed message. "You've got the yen rallying, you've got gold rallying, you've got treasuries rallying. Those are all defensive. Those are all things that would say, 'Hey, there's something actually wrong here.' And then you've got stocks rallying risk-on and you've got high yield spreads really tight."

For more expert insight and the latest market action, click here to watch this full episode of Market Domination.

This post was written by Melanie Riehl

Video transcript

Stocks are poised to end the week on a high note as traders debate with the Federal Reserve will cut by 25 or 50 basis points at its policy meeting next week.

Investors now pricing in a 59% chance of a 50 basis point rate cut there for more on the market moves.

Let's bring in Matt Miskin, John Hancock Investment Management, Co Chief Investment strategist, Matt, it's good to see you.

So, you know, I was talking to an economist this morning smart guy.

He said his base case next week, Matt, I mean, he's still expecting you get the traditional cut of 25.

But he said, you know what?

Suddenly it's, it's seeming like kind of a much closer call than it was that maybe we actually do get a super size 50.

What, what are you looking for next week?

Matt, our view is that we're gonna get a Dovish 25.

So they do 25 and then they promise a lot more to come.

Um The bond market is already pricing in five cuts by the end of the year and that is a lot.

I mean, you rewind a couple of months ago, you would never have thought this much and it is a lot year, you know, before the thought was, well, it's an election.

They're not gonna want to change policy.

Clearly, they're going ahead with it.

Um The labor da data is slowing, the inflation data is slowing.

We're the, we're at the start of a rate cutting cycle.

We want to get position for that.

We've got some great investment ideas for it.

Well, and I also know that you think that there can still be a soft landing here.

There has been sort of increasing debate about that, but three things need to happen, lay that out for us.

So first, the fed has to cut aggressively.

So the bond market has to be right in these fed cuts and they have to bring the fed funds rate down a lot.

Uh The second one is initial, jobless claims need to stay low.

So the, the jobs market really can't weaken them much more from here.

We don't want the unemployment rate going up much more.

So we need the jobs market to stay where it is and then find credit conditions need to remain calm and cool.

Uh So high yield spreads is the way we look at that high yield spreads need to stay tight.

Uh But you have those three things over the course of a week like this and markets love it.

Um You saw the twoyear yields fall a lot you saw the dollar fall a lot that's gonna help actually borrowing costs, it helps foreign revenues.

So that actually was pricing in a lot more of that soft landing scenario.

Matt.

Let's see.

So you're expecting 25 next week?

I'm just curious, let's say, let's say it didn't go that way.

Let's say you didn't get 50.

Would that in some way, would it reorder or would it, would it reshape how you want to be positioned in the market if that happened?

So, we don't want to lose the trees in the forest or is it the forest and the trees?

Um You know, one of those analogies.

Um but at the end of the day, it's just one meeting.

It's just one cut over the last three cutting cycles.

Uh They cut 17 times.

So we're debating one verse two on the first.

Usually there's 17 of them.

So the average decline in the fed funds rate since 1950 is about a 5% decline.

Uh If that average held through this time, we'd be back down to 50 basis points.

Um We don't think it's gonna signal much in terms of that.

Look, we're looking at utilities, uh defensive equities, health care, frankly, quality stocks with high Roe have done well in cutting cycles.

Uh That would be technology stocks.

You saw them come back this week and then on the bond side, Julie, I know we've been talking about bonds for the last couple of years on this show.

Uh, but they're really starting to work here.

So, um, those are kind of the key parts of the market we would focus on and gravitate to in a cutting cycle.

Well, and Matt, as you point out, we've also been trying to drill down with guests.

Ok, the fed cuts next week, then what, which you're sort of outlining that there's gonna be a lot more cuts that are coming.

So some of those picks that you were talking about what tends to happen and what tends to happen overall for stocks over the course of that whole cycle?

And is it just one trend or are there sort of many things that you see happening over the course of that period?

Yeah, Julie, I'm gonna start with something that's terribly uninformative in that it depends on whether or not we go in a recession or not.

Um So you go back into all these cutting cycles and if you don't go into recession, it's great stocks actually rally if you go into a recession.

Clearly, that's a different scenario.

Usually what happens though, regardless is the defensive parts of the market, the higher quality parts of the stock market take on leadership.

So cyclicals, lower quality parts of the market underperform and that is actually whether we get a recession or not.

Uh So we do like that kind of positioning and then if we go in a recession or there is any type of contraction, economic activity bonds are going to be a standout.

Uh So you could still see a double digit return at a fixed income here after the over the last year bonds are up 10%.

We still could see that furthermore, out of the treasury market in the next 12 months.

So we do want to have a decent allocation to that as well.

But the end of the day cutting cycle, whether we get a recession or not is gonna depend on that soft landing bullets we highlighted and we just want to position accordingly because lower rates mean better income opportunities.

You gotta take advantage of that.

Now, Matt, I want to switch gears a bit here.

You know, Gold Matt rose to another record high.

I mean, Bullion has just surged this year.

I'm curious what you make of that move.

What do you think the message gold is sending us here as investors?

Yeah, it has been a mixed message.

Uh It's complicated if it was like a Facebook post or Facebook status or something because you've got the yen rallying, you got gold rallying, you got treasury rallying.

Those are all defensive.

Those are all things I would say, hey, there's something actually wrong here and then you've got stocks rallying risk on and you've got high yield spreads really tight.