Federal Reserve Rate Cut Risks Market Bubble, Warns Morgan Asset Management Strategist

David Kelly, the chief global strategist at Morgan Asset Management, has warned that if the Federal Reserve's decision to cut interest rates this week is perceived as a response to political pressure rather than economic forecasts, it could increase risks for the stock market, bond market, and the U.S. dollar.

Kelly noted that while Wall Street investors have recently celebrated the prospect of the Federal Reserve resuming interest rate cuts after a nine-month pause, investors should adopt a more cautious stance following recent market surges and seek diversified allocations.

Kelly emphasized that the market is currently experiencing a bubble, and easing policies at this juncture could weaken rather than stimulate demand, ultimately proving detrimental to the stock market, bond market, and the U.S. dollar.

Kelly is not alone in predicting that the stock market's upward trend could reverse if the Federal Reserve resumes interest rate cuts. Strategists from Morgan Stanley, JPMorgan Chase, and Oppenheimer Asset Management have also cautioned that as investors shift their focus to potential economic slowdowns, a more cautious tone may replace the bullish sentiment.

Kelly acknowledged the market's expectations for the Federal Reserve's easing policies but argued that there is little evidence in the Federal Reserve's own economic growth and inflation forecasts to support such a decision. He noted that in the latest quarterly forecast, officials are likely to only slightly lower their economic growth and labor market expectations, while inflation forecasts remain above the Federal Reserve's 2% target until 2027.

Kelly questioned the necessity of an interest rate cut given the economic outlook, stating that by the fourth quarter of this year, inflation could be 1.2 percentage points higher than the Federal Reserve's target and still rising, while the unemployment rate could be only 0.3 percentage points higher than the target and stable.

Kelly also highlighted the political pressure on the Federal Reserve, noting that the president has been urging the Federal Reserve to cut interest rates for months. He suggested that if the Federal Open Market Committee (FOMC) members can truly ignore pressure from the government and colleagues, there could be multiple dissenting votes on both sides of the decision.