On Tuesday, Morgan Stanley’s(MS) Chief Economist, Torsten Slok, issued a warning suggesting that if the Federal Reserve maintains its current interest rates, the U.S. economy could experience a “hard landing” next year, potentially leading to a scenario reminiscent of the severe market downturn seen in 2022.
Despite cautioning against the risks posed by a high-interest-rate environment, Slok also anticipates that the Federal Reserve is unlikely to cut rates significantly in the near term. He predicts that the Fed may keep rates elevated for at least one to two quarters ahead to achieve the desired cooling effect on the economy. However, this stance could heighten the risk of a downturn in the stock market.
Concerns about a market downturn akin to that of 2022 were underscored by Slok during an interview on Tuesday. He pointed out that if the Fed refrains from substantial rate cuts this year, the ongoing “brief sweet spot” in the U.S. stock market could dissipate, primarily due to the negative effects of hawkish policies.
Slok warned that the Fed’s high-interest-rate environment has already inflicted significant damage on the balance sheets of highly leveraged consumers and businesses, as well as on banks and regional lenders.
“As the current ‘brief sweet spot’ gradually fades away, if the stock market fails to continue its upward trajectory, you will eventually see the dominant effects of high interest rates. This could be a scenario we witness in 2025, where we might face an even harder landing risk,” Slok cautioned.
Slok’s warning suggests that the market may potentially experience a situation akin to 2022 when rapid Fed rate hikes led to a significant downturn, with the S&P 500 index plummeting by 19.44% during that year.
Despite the cautionary tone regarding the risks of high-interest rates, Slok believes that the likelihood of rate cuts by the Fed is slim. In fact, Slok was among the earliest on Wall Street to predict that the Fed would keep monetary policy unchanged this year. He previously forecasted that the U.S. economy could unexpectedly exhibit robust performance, and rising inflation across multiple sectors could act as potential impediments to Fed rate cuts. He reiterated this viewpoint during Tuesday’s interview.
Current developments seem to validate his predictions. With inflation data consistently surpassing expectations over the past three months and a strong job market, most investors have become skeptical about rate cuts in June.
While June was previously considered the most likely month for rate cuts, doubts about rate cuts in September have now emerged. The CME FedWatch tool indicates that the market currently assigns only a 15% probability to the Fed’s first rate cut in June.
Some even predict that if the Fed aims to curb inflation, it may opt for rate hikes. However, while Slok forecasts that the Fed may refrain from rate cuts in the short term, he also disagrees with the notion of potential rate hikes by the Fed.
“I think, from the perspective of transmission mechanisms, they are more inclined to maintain high interest rates for a period, perhaps one or two quarters, and then achieve the goal of slowing down the economy.”
In conclusion, Morgan Stanley’s warning about a potential bear market, coupled with skepticism surrounding Fed rate cuts, underscores the uncertainties looming over the stock market amid evolving economic conditions.