Top-Level Takeaways
- After a brief pause in June, the FOMC announced its 11th rate hike of the current cycle on July 26, and Fed Chair Powell struck a more neutral tone in the press conference.
- Market pricing has become more aligned with Fed guidance for 2024 interest rate policy, but any deviations from both near-term and long-run expectations will have implications for the level of rates and the slope of the yield curve in the coming months.
- The recent economic data trend has revived the “soft landing” narrative in financial markets.
On July 26, the Federal Reserve’s Open Market Committee announced its 11th rate hike of the current cycle, raising the fed funds target range by 25 basis points to 5.25%-5.50%. The official statement from the meeting was essentially unchanged. In the press conference that followed, Jerome Powell struck a more neutral tone relative to past events, refusing to commit to a pause or continuation of rate hikes in the coming meetings.
Instead, Powell reiterated data dependency many times in his response to questions regarding the path of future Fed policy. On the data front, recent key releases portray a U.S. economy that remains more resilient than many expected at this point, buoyed by low unemployment and steady consumer spending. Consequently, the “soft landing” narrative was revived in financial markets as a plausible outcome for the U.S. economy.
The implication for markets has been that the Fed might have to keep the funds rate higher for longer, an idea that has been met with much resistance this year amid prevalent recession speculation and a mini-banking crisis. In mid-July, the bond market was pricing for roughly 150 basis points of rate cuts in 2024. By the end of July, that figure shrunk to just over 110 basis points.
It’s worth highlighting that the median FOMC forecast also calls for rate cuts next year, on the presumption that disinflation and increased unemployment will allow the central bank to bring the policy rate down from more restrictive territory, albeit at a more moderate pace than even more recent market pricing. As for the terminal fed funds rate, August began with the market pricing a 40% probability of a final 25-basis-point rate hike this year versus the Fed’s June median forecast of a 5.625% funds rate at year-end (one more 25-basis-point hike).
There are a few factors to consider relative to current market pricing.
During the next 12 to 18 months, the current yield curve already accounts for multiple rate cuts. For those in the “rates are going to fall camp,” it’s important to understand what is already accounted for in current spot rates. If short-term rates do indeed have to remain elevated for longer than is anticipated given economic strength, then the front-end and belly of the yield curve would need to reprice for higher rates.
Lastly, the market is pricing a higher long-run rate relative to the Fed, which is essentially the perceived optimal level of short-term rates that allows for economic expansion with stable inflation. This is a very difficult rate to forecast, but a higher, long-run neutral rate expectation has a greater impact on the long-end of the curve.
Visit almfirst.com to read about the latest economic data and market trends.
Jason Haley joined ALM First in 2008 and is the firm’s chief investment officer. He heads ALM First’s Investment Management Group (IMG), which is responsible for leading the investment process and investment theme development. Haley also oversees all capital markets activities, including portfolio management, trading, market research and commentary, and execution of hedging and funding strategies for the firm’s depository clients. He holds an MBA with a concentration in finance and a BBA with a concentration in marketing, both from The University of Mississippi.
Powell Reiterates Data Dependency, Market Revives Soft Landing Narrative
Top-Level Takeaways
On July 26, the Federal Reserve’s Open Market Committee announced its 11th rate hike of the current cycle, raising the fed funds target range by 25 basis points to 5.25%-5.50%. The official statement from the meeting was essentially unchanged. In the press conference that followed, Jerome Powell struck a more neutral tone relative to past events, refusing to commit to a pause or continuation of rate hikes in the coming meetings.
Instead, Powell reiterated data dependency many times in his response to questions regarding the path of future Fed policy. On the data front, recent key releases portray a U.S. economy that remains more resilient than many expected at this point, buoyed by low unemployment and steady consumer spending. Consequently, the “soft landing” narrative was revived in financial markets as a plausible outcome for the U.S. economy.
The implication for markets has been that the Fed might have to keep the funds rate higher for longer, an idea that has been met with much resistance this year amid prevalent recession speculation and a mini-banking crisis. In mid-July, the bond market was pricing for roughly 150 basis points of rate cuts in 2024. By the end of July, that figure shrunk to just over 110 basis points.
It’s worth highlighting that the median FOMC forecast also calls for rate cuts next year, on the presumption that disinflation and increased unemployment will allow the central bank to bring the policy rate down from more restrictive territory, albeit at a more moderate pace than even more recent market pricing. As for the terminal fed funds rate, August began with the market pricing a 40% probability of a final 25-basis-point rate hike this year versus the Fed’s June median forecast of a 5.625% funds rate at year-end (one more 25-basis-point hike).
There are a few factors to consider relative to current market pricing.
During the next 12 to 18 months, the current yield curve already accounts for multiple rate cuts. For those in the “rates are going to fall camp,” it’s important to understand what is already accounted for in current spot rates. If short-term rates do indeed have to remain elevated for longer than is anticipated given economic strength, then the front-end and belly of the yield curve would need to reprice for higher rates.
Lastly, the market is pricing a higher long-run rate relative to the Fed, which is essentially the perceived optimal level of short-term rates that allows for economic expansion with stable inflation. This is a very difficult rate to forecast, but a higher, long-run neutral rate expectation has a greater impact on the long-end of the curve.
Visit almfirst.com to read about the latest economic data and market trends.
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