The stock market won't see a sustained rally until the Fed starts cutting interest rates - and that won't occur until these 3 things happen, according to JPMorgan

• The stock market won't see a sustained rally until the Fed starts to cut interest rates, JPMorgan said.
• "As long as central banks raise rates or keep them at current high levels, we believe assets will be rangebound," the bank said.
• The Fed will need to see a combination of three things to start cutting interest rates, according to JPMorgan.

The stock market won't see a sustained rally until the Federal Reserve begins to cut interest rates, and it has no reason to cut them unless a combination of three factors occurs, JPMorgan said in a Monday note.

The S&P 500 has surged 14% from its mid-October low, but more and more investors are growing increasingly concerned that the jump is nothing more than a bear market rally that will give way to more downside as the Fed gears up for another interest rate hike next month.

"As long as central banks raise rates or keep them at current high levels, we believe assets will be rangebound with a more pronounced downside risk," JPMorgan's Marko Kolanovic said.

Instead, the Fed needs to cut interest rates for the stock market to mount a sustained rally that could give way to new highs.

Kolanovic said the Fed could cut rates at some point next year, but only if a combination of factors materializes, including increased unemployment, declining inflation, and "something breaking in financial markets."

In its bid to tame elevated inflation, the Fed has already raised rates by 375 basis points so far this year, and it's expected to hike rates by another 50 basis points at its December FOMC meeting. Investors expect a follow-on rate hike of 25 basis points in January, before the Fed ultimately pauses its rate hikes to see where the economy stands.

And a resilient economy means the likelihood of interest rate cuts is far off, according to JPMorgan.

"As an increase in unemployment is not likely to happen very soon, markets will be on edge between waiting for better inflation data, slowing economy and earnings, and rising risks of a financial accident," Kolanovic said.

But an economic recession that materializes in late 2023 could be the final straw that causes the Fed to ease financial conditions via interest rate cuts and a pause or reversal in its balance-sheet reduction program.

"We believe the drag from an anticipated 500 basis points Fed tightening will build and last week we incorporated a mild recession into our forecast at the end of next year. However, recessions are disruptive events that normally reflect the interaction of Fed tightening with shocks and the response of a vulnerable private sector. This recipe is not yet in place and it is unlikely that recession will take hold as we turn into the New Year," Kolanovic wrote.

Until then, investors shouldn't put too much stock in a stock market rally unless the Fed gives signs that it's going to pivot away from tightening and towards easing financial conditions.