Fed Goes Big (50 bps) with 50 More on Tap for 2024, Treasury Yields Go Up, What’s Next?
This week’s long awaited rate cut was the first since the onset of the pandemic in March 2020. The 50 bp rate cut was cheered by equity markets. However, there is fear that there is a “panic factor” in the decision and maybe the Fed started cutting too late (Fed minutes revealed several committee members were in favor of a July rate cut). 30-day SOFR is now 4.85%.
What’s next? The accompanying “dot plot” (economic and rate predictions by Fed policy makers) revealed that they have become very dovish in the last 100 days. A majority are predicting 2 more cuts, a total of 100 bp for the year: putting the policy rate at 4.4% by year-end (as opposed to June’s dot plot showing 5.1% at year-end). The dot plot, why? Perhaps the reason lies in the new year end unemployment rate prediction of 4.4% (as opposed to 4.0% in June – which was surpassed almost immediately as unemployment hit 4.3% last month). Futures markets predict 3 more cuts by year end (with a 20% chance of 4 more cuts). That is followed by a predicted 4 additional cuts in 2025, bringing SOFR down to ~3.35%. Powell mentioned “recalibration” of risks in his post meeting remarks. Inflation is now “well anchored” and the Fed has turned its attention to employment. He pointed out that July 2023 stats were 3.5% unemployment and 4.2% inflation (hot) and today’s numbers are 4.2% unemployment and 2.2% inflation (cool). More from Powell on Fed employment concerns: “Labor market is in solid condition. This will help keep it there” and “We aren’t behind…We did this to not get behind” (see dot plot charts and commentary).
Below are this week’s Fed unemployment predictions compared to their predictions in June. Note that 4.4-4.5% unemployment for 2024 and 2025 was not predicted until this meeting. The Fed is also predicting 100 bps in cuts this year and 100 bps next year. Therefore, the Fed now believes that it will require 200 bps in cuts just to keep unemployment from rising from today’s level.
Speaking of data, Powell again called out the survey methodology weaknesses in the BLS numbers that overstate payrolls: “July and August payrolls were artificially high” and discussed later downward revisions from the more accurate QCEW report. Regarding future cuts, is 50 bps the “new normal”? Powell made it clear that the big cut was a “good strong start” but should not be considered the norm. The pacing of future cuts will be (stop me if you heard this before)… “Data dependent” and “meeting by meeting.”
Why Did Treasury Yields go Up? The Fed rate is a floating rate that determines the cost of money for US Banks and therefore floating rate borrowers. The 10-year Treasury yield is determined by a worldwide market that averages $880 billion dollars a day of trades and totals $27 trillion. Treasury yields are a reflection of investor sentiment regarding the direction of rates over the next 5-10 years. Long term fixed rates do not move in lockstep with short term floating rates. When the Fed announced the 50 bp cut, treasury yields rose on the news. Why? The cut had been “baked in” and the market then interpreted the cut’s future effects as possibly stoking inflation. And yes, Treasury markets are now quite “data dependent” during periods of rate volatility. Treasuries will continue to react to economic reports regarding prices (PCE, CPI) and employment (Payrolls, Unemployment report, etc.). Yesterday’s initial jobless claims came in at 219K (expected 229K) showing an unexpectedly strong jobs market the day after Powell’s evident concern regarding employment. Look for this cycle to be “bumpy” with anomalies and inconsistencies along the way.
Also note that the “elephant in the room” this time is the US debt level. Note that the last 2 big rate cutting cycles occurred in 2000 (dot com bust) and 2007 (GFC). The total US debt was $5.6T (2000) and $9.0T (2007). This time it’s $33T. Interest on the debt for fiscal 2024 exceeded $1T and is more than the entire US defense budget. These rate cuts are not occurring in a “vacuum”, there are supply dynamics in play that may “distort” the relationship between fixed and floating rates. Stay tuned…
By David R. Pascale, Jr., Senior Vice President at George Smith Partners.