The Federal Reserve, led by Chairman Jerome Powell, is expected to decide on September 18 whether to lower interest rates.
The central bank has signaled that the US economy may reach a "soft landing," meaning inflation will decline without causing a severe recession.
However, analysts at BCA Research in a note dated Monday cast doubt on this optimism, arguing that the economy still faces challenges.
"Investor sentiment is very positive, with little cash out of the market, and US equities are trading at 21x expected future earnings (very optimistic)," the analyst said. This optimistic view reflects confidence in the Fed's ability to manage the economy without causing a recession.
Both individual and institutional investors are fully invested in the equity market, leaving little cash outside the market. According to analysts at BCA, this kind of excessive optimism is often followed by a market correction, especially if economic conditions start to deteriorate.
Historically, the stock market often declines after the first interest rate cut by the Federal Reserve in a cycle. This pattern has been observed in past historical data, such as in 2001 and 2007.
An exception occurred in 1995, when the Fed managed to cut interest rates without causing a recession. However, today's economic situation is very different from the mid-1990s.
Unemployment is rising, and the job market is showing signs of weakness. This is supported by the Sahm rule, which was triggered last month, pointing to the possibility of an impending recession.
Analysts at BCA paint a bleak picture of the job market. Job creation has plunged by more than a million in the last two years, and revised nonfarm payroll data show that job growth has been exaggerated.
Although jobless claims did not jump dramatically, the overall trend points to weakness in the job market. The decline raises concerns about the long-term sustainability of the economic expansion and the Fed's ability to achieve gradual tapering.
It is expected that even if the Fed continues to cut rates as expected, monetary policy will remain tight for some time. BCA analysts warned that the benefits of easier monetary policy may not materialize quickly enough to avoid a recession.
BCA Research suggests investors be cautious with their portfolios due to current economic risks. They recommend holding fewer stocks and bonds, with a preference for government bonds as a safer option in the event of a recession.
