Beware of risks to financial markets

As it became clear recently that the United States Federal Reserve was hitting the pause button on interest rate hikes after its fastest rate hiking cycle in history, financial markets have rallied sharply on bets that the next move would be rate cuts. The benchmark S&P 500 index for instance has jumped more than 15 per cent since late October and is reckoned to be overvalued by most metrics. Stocks listed in the Singapore market have also recovered over the same period. However, there is a danger that these knee-jerk rallies could turn out to be what market players call “a dead cat bounce” – temporary phenomena that could easily reverse.

There are a lot of negative developments that could put paid to the euphoria. One is the fact that even if rate cuts happen – the timing of which remains uncertain – interest rates will still be high on a historic basis, that is, relative to the 15 years before 2023. This is true for the United States as well as the euro zone. It means that both households and companies will continue to face higher borrowing costs, especially after their fixed rate loans taken when rates were near zero get reset at higher levels. Many economists point to a high risk of recession in 2024 which will weaken corporate earnings and lead to market corrections. Economists at BCA Research, for instance, project the most likely range for the S&P 500 at 3,300 to 3,700 in a recession scenario, compared with its current level of close to 4,700.