Investing.com -- UBS analysts said in a note that aggressive rate cuts by the Federal Reserve could set the stage for a new stock market bubble.
In their recent note, UBS explains that historically, markets have reacted positively in the short term after the first rate cut, gaining an average of 4% over eight months.
"If there was a recession, markets were down 10%; if there was not, they were up 20% - (with recessions happening on average 5 months after the start of the rate cut with a recession occurring 55% of the time over the period)," said UBS
UBS is concerned that a more aggressive Federal Reserve could drive rates lower than expected, potentially triggering a bubble.
They point out that the market expects a trough Fed Funds rate of 2.8%, while historically, rates have fallen below neutral levels during downturns.
UBS argues that a weaker economy, less sensitive to rate changes than in the past, could push rates lower and weaken the U.S. dollar, forecasting EUR/USD at 1.15 and JPY/USD at 130 by the end of 2025.
For equities, the analysts are cautious, noting that stock markets have already seen significant gains leading up to the anticipated rate cuts, leaving limited room for further upside without worsening economic news.
"Equities are only marginally cheap if you believe (as we do but many don't) that Gen AI will push up productivity growth by 1% from 2028," says UBS.
The upside risk, however, is that an aggressive Fed could create conditions for a market bubble.
"Short-end-led yield curve steepening is good for consumer (ex luxury) and defensives," adds the bank. "We stay overweight these two areas (see here). Style: We think small caps outperform (3X more floating rate debt than large cap), quality outperforms and to a lesser extent so do growth stocks."