Aggressive Fed rate cut next week could backfire, put big tech companies in focus

Investing.com — If the Federal Reserve cuts spending deeply next week at a time when economic growth appears intact, it could backfire and spook rather than support the market, BCA Research said in a recent report.

A bigger rate cut now that economic growth looks stable would fuel speculation about the economy, BCA said, but a “much more important reason why aggressive dovishness would backfire … is the yen carry trade.”

The yen carry trade has been popular for years as traders borrowed yen at low rates to finance trades such as higher-yielding stocks. At the heart of the trade was confidence that the Bank of Japan would remain ultra-dovish on monetary policy amid a prolonged battle with deflation and sluggish economic growth.

According to BCA, further unwinding of the yen-carry trade, which is closely tied to technology company valuations, would put a significant dent in the valuations of big tech companies, leading to calls for further aggressive cuts that would likely “guarantee the recession the Fed is trying to avert.”

BCA believes that big tech and the yen share a “reflexive” relationship. The steady rise of big tech has made it a ‘go to’ destination for the yen carry trade, while “the appreciation of tech valuations has likely required the leverage of borrowing yen at near-zero interest rates.”

An aggressive rate cut would hurt the dollar and boost the yen, BCA said, leading to a “further decline in valuations of US technology stocks relative to bonds.”

A recession is not as far-fetched as some think, as bond traders already appear to be preparing for a soft landing.

According to BCA, the US yield curve is already pricing in a “full recession in the next six months, with 170 basis points of rate cuts priced into the February 2025 Fed Funds contract.”

“This implies at least two half-percentage-point rate cuts over the next five policy meetings, a pace normally seen only during recessions,” the report said.

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The Fed begins its second meeting on September 17 and is expected to cut rates by 25 basis points.

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