Why Fed rate cuts could mean corporate earnings will disappoint

Markets are eagerly awaiting rate cuts, with as many as eight cuts expected in the next year, but that might be bad news for earnings, according to Trivariate Research.

That many cuts point to an expected worsening in economic conditions, the analysts note.

“Our view remains that if the economy erodes to the magnitude embedded in the above Fed path, earnings will materially disappoint, enough so that there will be a growth scare,” the analysts wrote in a Sunday note.

They said several factors would necessitate two percentage points worth of cuts, and such a move down in interest rates would point to a slowing economy, higher unemployment, and US companies seeing less pricing power.

The analysts said consensus forecasts are for 12.6% year-over-year earnings growth for the fourth quarter, a more than twofold increase, and a “meaningful uptick” from the 4.8% year-over-year growth estimated for the third quarter.

“The quarterly year-over-year growth expectations from the consensus remain incredibly high for each quarter — with expectations above the long-term average and median growth every quarter next year.”

The analysts’ prediction for an upcoming earnings hit could strengthen amid further weakening of economic data.

Unemployment jumped to 4.3% in July, up from 4.1% in June, sparking fears that the economy was set to slow.

US corporations, meanwhile, are already seeing lower pricing power as customers continue to search for value and cut back on purchases amid inflation weariness. According to data from S&P Global’s latest flash US Composite PMI Output Index, average prices for goods and services are rising at their slowest rate since January.

The Fed has kept rates steady this year, but at the central bank’s Jackson Hole conference last month, Chair Jerome Powell acknowledged a cut is likely at this month’s meeting on September 18.