A Wall Street stock chief explains how the Fed has brought the stock market dangerously close to disaster — and why rate cuts might be too late to avoid it

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  • The Federal Reserve’s expected rate cuts may be ineffective in terms of avoiding a crisis in the economy and stock market, according to Barry Bannister, the head of institutional equity strategy at Stifel.
  • He says interest rates are already consistent with levels that prevailed in 1998, 2000, and 2007 — right before prior crises.
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The Federal Reserve‘s move to preemptively lower interest rates before disaster strikes may ultimately prove to be ineffective.

That’s because the central bank has already raised interest rates to levels that are consistent with previous downturns in the stock market and economy, according to Barry Bannister, the head of institutional equity strategy at Stifel.

One reason why the Fed feels compelled to cut now stems from its concern that borrowing costs might be dangerously close to the so-called neutral interest rate at which growth is neither booming nor shrinking. There’s no pinpointed consensus on what this theoretical rate is, though Bannister estimates it’s around 2.3%.

But what many people agree on — from Bannister to Fed Chairman Jerome Powell — is that the neutral rate has fallen over the decades as worker productivity and demographic trends deteriorated.

Simply put, it now takes a lower level of interest rates to cross the threshold that would be restrictive for the economy and threatening to the stock market’s gains.

The Fed has already come too close, Bannister said, and he’s skeptical of the impact of Wednesday’s expected rate cut. His chart below shows that it would take more aggressive rate cuts to clear the danger.

Stifel

“Two rate cuts and a stronger economy are nice, but they may not be enough,” Bannister told Business Insider by phone.

If the Fed doesn’t lower its benchmark rate again soon after the July 31st meeting, it would be making a “terrible policy mistake” to which markets react negatively, Bannister said.

“Cutting twice and having neutral rise slightly only returns you to a fairly tight level that existed in the summer of 1998, 2000, and 2007, which you’ll see is before difficulties in the market,” Bannister said.

Read more: Morgan Stanley scoured 100 sets of data and warns we’re ‘just outside the danger zone’ of the next recession. Here’s how it says to prepare.

It would take a dose of inflation — which has largely been elusive — and strong growth to lift the so-called neutral rate slightly. Combine a higher neutral rate with two rate cuts from the Fed, and you just might relieve some stress from the markets this summer, Bannister said. But there are no guarantees.

“We think that they’ll err on the side of caution and cut both July 31st and in September, Bannister said. “However, it might require some market weakness and data weakness in the month of August, as well as trade disruptions, to cause the Fed to go ahead with the September cut which we think is necessary.”

Since last September, he has recommended a more defensive investing approach, expressed by buying utilities, REITs, and consumer staples. Those are also the sectors that have led the stock market’s gains over the past year.

Additionally, he’s recommending bank stocks as he believes they can remain profitable for as long as the economy avoids a recession.

One notable defensive sector he’s avoiding is healthcare because of his view that the political pressures to lower drug prices will last for many years.

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