Wall Street's most accurate analyst: It's not about "to cut or not to cut" anymore, nor is it about "when to cut", but rather "will rate cuts still work"

With the recent volatility in the US financial markets and weak economic data, a key question has emerged in the mind of Michael Hartnett, Chief Strategist at a US bank.

Hartnett, known as one of Wall Street's most accurate analysts, wrote in his latest Flow Show note that the "persistently high real interest rates are slowly and profoundly damaging US consumers and the labor market." Global rate cuts are no longer a question of "whether" or "when," but rather a question of "whether rate cuts are effective."

One compelling evidence is the sudden and unprecedented drop in credit card debt last week, which may be related to the Federal Reserve's decision to hold interest rates steady.

In the second quarter, the average interest rate on interest-bearing credit card accounts reached a historical high of 22.76%, burdening ordinary households with an unprecedented high interest rate burden.

Meanwhile, small businesses, as an important part of economic vitality, are directly affected by benchmark interest rates. Currently, the real benchmark interest rate in the US is as high as 6.5%, the highest level this century. This not only increases the operating costs of small businesses but may also inhibit their expansion and innovation capabilities.

As recession warnings continue to flash, Hartnett points out that the urgency of rate cuts is increasing, but the key lies in whether the magnitude of the rate cuts is sufficient to have a substantial impact. Here, he suggests that significant rate cuts are needed to be effective.

Key indicators suggest market remains optimistic

Despite experiencing some volatility, the consensus among investors still leans towards expecting a soft landing from the Federal Reserve rate cuts, supporting the stock market. However, according to Hartnett, some key market indicators have yet to breach technical levels that would shift Wall Street's narrative from a soft landing to a hard landing.

Hartnett believes that if key technical levels in the market are breached, such as the 30-year Treasury yield falling to 4%, high yield CDX spreads reaching 400 basis points, or the S&P 500 index dropping below 5050 points, Wall Street's narrative may shift from a soft landing to a hard landing.Hartnett emphasized the importance of the 200-day moving average of the SOX index and the XLK index of large-cap technology stocks. If certain key technical levels or psychological barriers are breached, market participants (especially traders) may change their trading strategies and target prices, predicting a 10% decline from current levels to reach or near the highs of 2021.

Hartnett believes that although market sentiment currently leans towards expecting a soft landing from rate cuts, worse economic data and/or market volatility are needed to break this consensus. The consensus is:

Fed rate cuts → Probability of a soft landing exceeding 75% → Stocks > Bonds, Cyclical stocks > Defensive stocks, Large-cap tech stocks > Small-cap stocks, US > other regions in the world.

Hartnett suggests focusing on housing, small business confidence, and is not optimistic about AI in the second half of the year

Setting aside emotions, Hartnett also outlined his personal views on policy and profits, writing that a soft landing depends on signs that rate cuts in the second half of the year will stimulate market sentiment and household spending. However, biotech stocks (the longest-dated stocks) are "not doing well," and US retail stocks (non-essential consumer goods at a relative low point in 12 years) have not yet been boosted.

Finally, Hartnett believes that if rate cuts can boost consumer confidence and spending, then housing market and small business commercial confidence will be key indicators to watch:

Housing (mortgage purchase applications near the lowest levels since 1995, refinancing at the lowest since 2000), many millennial parents have to wait several years to buy a house... If they don't buy now, it indicates significant concerns about the labor market.

Small business confidence is suppressed by high financing costs (as well as taxes/regulations): If the NFIB small business confidence index, to be released next time (Tuesday), rises from the previous value of 92 to above 98 (50-year average), this will be a very optimistic signal... Conversely.

Regarding the artificial intelligence track, Hartnett remains in the "sell" camp, expecting AI stocks to remain quiet in the second half of the year until earnings per share growth becomes more apparent.

In the current economic environment, Hartnett believes that investors should focus on assets that can perform better under lower yields, such as government bonds, real estate investment trusts, small-cap stocks, and some troubled emerging markets like Brazil (weak dollar investments) He also believes that there are huge opportunities in the real estate markets of the UK, Canada, Australia, New Zealand, and Sweden. All of these markets are primarily based on floating mortgage rates, with interest rate transmission mechanisms much faster than the United States. At the same time, he also warns investors to be cautious of global retail stocks that may be severely affected by a hard landing