According to Goldman Sachs, while a 50bps rate cut by the Fed on Wednesday may seem positive for risk assets in the short term, there are potential challenges that could arise.
In a note to clients on Wednesday, the investment bank discussed what could go wrong for risk after such a large rate cut.
The bank highlighted that while risk assets might rally in the next 5-10 sessions, a slower-than-expected pace of rate cuts could disappoint markets.
Analysts point out that “a disappointment to the perception that the Fed could be moving slower than the 1y1y nominals suggest” could lead to a re-tightening of financial conditions, which in turn might pressure real rates and strengthen the dollar.
Furthermore, they state a slow recovery in economic surprises, alongside weakness in China and Europe, could also negatively affect market sentiment.
One of the key risks outlined is the potential for geopolitical escalation, particularly in hotspots such as Russia-Ukraine, the Middle East, and the South China Sea.
If these tensions rise, Goldman Sachs expects a flight to safe-haven assets, such as Treasuries and German government debt.
Moreover, analysts raise concerns about China, where “the latest money supply and PPI data” suggest that the economy may be entering a deflationary phase, with broader credit issues spreading to manufacturing and services.
Overall, while a 50bps rate cut might initially provide a boost to risk assets, Goldman Sachs believes there are several factors, including slower Fed action, geopolitical risks, and global economic weakness, that could quickly reverse sentiment.
