The stock market is poised for a sell-off as an overly hawkish Fed could dash hopes for interest rate cuts, Morgan Stanley’s Mike Wilson says

• The stock market is poised for a sell-off as investors put too much hope in the Fed cutting interest rates.

• Morgan Stanley’s Mike Wilson said while a pause from the Fed is likely, interest rate cuts are not.

• “If the message delivered at this meeting is more hawkish, it could provide a near-term negative surprise for equities,” Wilson said.

Investors are putting too much hope into the idea that the Federal Reserve will cut interest rates later this year, and that could set the stock market up for a sell-off, according to Morgan Stanley’s equity strategist Mike Wilson.

According to Wilson, the Fed’s FOMC meeting later this week should include another interest rate hike, as the market currently expects, but hawkish comments from the Fed could also reprice current interest rate expectations from cuts by the end of the year to a long-standing pause.

“We’ve found that investors are less focused on the upcoming Fed meeting as a potential risk event for equities,” Wilson said in a Monday note. But the FOMC meeting on Tuesday and Wednesday could turn into a catalyst for lower equity prices if Fed chairman Jerome Powell alters the market’s view about the future direction of interest rates.

“If the message delivered at this meeting is more hawkish, it could provide a near-term negative surprise for equities,” Wilson said.

The market currently expects a 25-basis-point interest rate hike on Wednesday, followed by a pause that lasts until the two last FOMC meetings in November and December, in which two 25 basis point interest rate cuts are forecasted, according to the CME FedWatchTool.

Instead, Wilson expects the Fed to pause interest rate hikes and cuts through the end of the year, essentially leaving the Fed Funds rate at a constant level of just over 5%.

“Should the message delivered at this meeting lead to a re-pricing of bond market expectations for rate cuts in the second half of ’23(i.e., rate cuts get priced out, leading to an implied path that’s more in line with our economists’ view for a pause), that could ultimately be a negative surprise for equities,” Wilson explained.

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That’s especially likely given the solid upside stocks have enjoyed so far this year, with the S&P 500 up nearly 10% year-to-date. Also boosting Wilson’s confidence in his outlook is the fact that the upcoming FOMC meeting on Wednesday “is one of the least talked about in recent memory,” Wilson said.

While inflation remains elevated and the economy continues to stay resilient, cracks are appearing that could give the Fed pause in continuing with its aggressive interest rate hike policy, including the collapse of three US banks over the past two months.

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