According to a recent report, bond investors are pricing in the likelihood of imminent Federal Reserve interest rate cuts in the first half of the coming year, reflecting concerns over a slowing US economic growth trajectory and easing inflation.
The report by the Government Accountability Office indicates that the Federal Reserve’s decision to refrain from raising rates is influenced by the evolving economic landscape, with inflation trends playing a crucial role in determining the timing of potential monetary policy easing.
Inflation Metrics Signal Stability
A pivotal factor in this assessment is the release of the latest US Personal Consumption Expenditures (PCE) price index, the Federal Reserve’s preferred inflation measure. The PCE price index for October remained unchanged, following a 0.4% increase in September.
The year-on-year gain through October was 3.0%, a notable decline from the 3.4% reading in the previous month. This shift in inflation dynamics is a significant development that could potentially change the Federal Reserve’s policy stance.
“The Fed is on hold, and (this report) gives them more comfort in staying on hold. What they’re doing is working,” commented Robert Pavlik, Senior Portfolio Manager at Dakota Wealth Management.
He suggested that a 25- to 50-basis-point rate cut before the end of the summer in 2024 would align with the economic slowdown, allowing the Federal Reserve to fine-tune its policy tools.
Traders’ confidence in the possibility of rate cuts increased earlier in the week when Fed Governor Christopher Waller, known for a hawkish stance, hinted at a potential rate cut in the coming months.
All eyes are now on Fed Chair Jerome Powell’s upcoming remarks to gauge the central bank’s stance and whether he echoes Waller’s comments or provides a different perspective.
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Market Signals Point to Anticipation of US Federal Reserve Rate Cuts
Various indicators in the bond and money markets are reflecting these expectations:
Fed Funds Futures:
Traders are pricing in approximately a 45% chance of a rate cut at the March 19-20, 2024 meeting, with a probability increasing to about 75% at the April 30-May one meeting, according to the CME FedWatch Tool.
Overall, the rates market anticipates around 100 basis points of cuts by the end of 2024.
Yield Curve:
The yield curve, measuring the gap between yields on U.S. two-year and 10-year Treasury notes, has been narrowing its inversion. This phenomenon, known as a “bull steepener,” often occurs when the Fed is expected to cut interest rates.
SOFR Futures:
Secured Overnight Financing Rate (SOFR) futures for March 2024 indicate a 50% chance of a 25-basis-point cut at that meeting.
June 2024 SOFR futures are pricing in at least one Fed cut, with a 76% probability of two 25-basis-point rate reductions.
OIS Forwards:
The overnight index swap (OIS) forwards market shows an increasing expectation of rate cuts starting in March.
The three-month by six-month OIS forward suggests over a 40% chance of a 25-basis-point amount by March, while longer-dated OIS forwards indicate 100% odds of at least one rate cut by June and a 78% chance of two rate cuts by mid-next year.
As investors closely monitor economic indicators and Federal Reserve communications, the bond market is bracing for a potential shift in monetary policy in response to evolving economic conditions.
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