The Bank of Japan's sudden U-turn on policy has ignited strong reactions on Wall Street this week, with investors now eyeing significant interest rate cuts from the Federal Reserve.
Bank of America's chief investment strategist, Michael Hartnett, believes that Wall Street has effectively forced the Bank of Japan into the decision to halt rate hikes during periods of market turmoil.
In his latest "Flow Show" report, Hartnett analyzed the implications of one of the most volatile weeks in global markets since the onset of the COVID-19 pandemic.
"Wall Street has now (painfully) stopped BoJ hikes... its next goal appears to be bossing the Fed into big rate cuts," Hartnett wrote.
Big Cuts Are Needed To Avoid Hard Landing
Hartnett indicated that the elevated interest rates are beginning to take a toll on small businesses. He suggested that significant rate cuts are necessary to avoid a hard landing for the economy.
Currently, the U.S. prime rate - which is the lowest interest rates at which small businesses can borrow - stands at 6.5% in real terms, the highest level this century, making borrowing costs particularly burdensome for the real economy.
Higher-for-longer real rates are gradually and decisively hurting the U.S. consumer and labor market, according to Hartnett.
He stressed that global rate cuts are no longer a question of "if" or "when," but rather a matter of whether the cuts will be effective.
"Big cuts are needed to work," he said.
Soft Landing Contingent On Reactions To Lower Interest Rates
A soft landing for the economy, Hartnett suggested, would depend on whether lower interest rates in the second half of the year can reinvigorate consumer spending and business activity.
He pointed to key indicators to monitor, such as housing market data and small business sentiment.
According to the analyst, a recovery in mortgage purchases, refinancing activity, and small business sentiment driven by lower interest rates would be a positive indicator.
Sell AI Stocks, Buy Laggards After The First Cut
Hartnett maintained his stance of "sell the first cut," anticipating that leadership in AI and AI-derivative plays may struggle in the second half until earnings-per-share gains become more visible.
He recommended that investors "buy assets strangled by 5% yields" that could benefit from a decrease in yields to 3-4%.
These assets include government bonds, REITs, small-cap stocks, and distressed emerging markets like Brazil, which could benefit from a weaker dollar.
Exchange traded funds investing in these assets include the iShares 20+ Year Treasury Bond ETF
He also highlighted potential opportunities in housing markets in countries like the UK, Canada, Australia, New Zealand, and Sweden, where floating mortgage rates could lead to a quicker transmission of lower rates into increased consumer confidence.
Finally, Hartnett suggested that global retail stocks could present the best buying opportunity in the event of a "hard landing" and a negative payroll print in the coming months, as these stocks, much like REITs, have already priced in a recession.
