[THE VIEW]Timing of Fed Rate Cuts and Investment Considerations

U.S. Stocks Thrive on AI Optimism
September Rate Cut Could Bring Opportunities
for Startups and Small Businesses Facing Funding Challenges
Caution Needed as Shifts in Investment Destinations May Trigger Volatility

The U.S. unemployment rate announced earlier this month recorded 4.3%, higher than expected. The market judged that the Federal Reserve's high interest rates aimed at controlling inflation have instead fueled an economic recession. Although expectations for a rate cut increased, the stock market plunged. Generally, interest rates are often inversely related to stock prices because they affect corporate borrowing costs. However, the expectation of a rate cut earlier this month coincided with a stock price decline. This was due to growing concerns about a hard landing for the U.S. economy.

The 2007 recession shares many similarities with the current situation in 2024. The minutes of the Federal Open Market Committee (FOMC) meeting in August 2007 show that while risks to growth had somewhat increased, there were concerns about inflation. At that time, the Fed maintained the benchmark interest rate at 5.25%.

It had been 19 months since the yield curve inversion between short- and long-term rates. Then, in September, the Fed implemented a 'big step' by cutting the benchmark rate by 0.5%, followed by additional rate cuts in October and December. Some argue that the high interest rates were maintained for too long, slowing economic growth.

As of August 2024, there are many similarities to that period. It has been 19 months since the yield curve inversion, and the most recent FOMC meeting expressed concerns about inflation while maintaining high interest rates. Maintaining high rates has suppressed investment and slowed corporate growth. However, unlike earlier this month, other recently released indicators have come out more in line with the Fed’s intentions, increasing expectations for a soft landing. Fortunately, many market participants agree that the time for rate cuts is approaching, though there is concern that the response might be too late since the next FOMC meeting is not until September.

Despite the prolonged period of high interest rates, the U.S. stock market has been thriving in 2024. In August 2007, stock prices had fallen more than 7% compared to the mid-July 2007 peak. The current stock market rise is attributed to optimism about AI and the new growth opportunities it brings. Additionally, several inflation indices and retail sales figures remain positive, which is also believed to have influenced the market.

If interest rates are cut, companies that have struggled to grow due to financing difficulties could see a breakthrough. Many startups and relatively smaller companies are highly sensitive to interest rate changes in their valuation, so a rate cut could lead to higher valuations.

Companies that postponed initial public offerings (IPOs) due to valuation concerns may also return to the IPO market. While the fundamental value of companies that led the stock market during the high interest rate period is unlikely to have changed, if the stock price rise was caused by investor overheating, price fluctuations may occur depending on changes in investment destinations, so caution is advised.

Seonggyu Park, Professor at Willamette University, USA