Updated Rate Outlook: Anticipating 2-3 Fed Cuts Amid Market Volatility
As we focus on the Fed's upcoming announcement on July 31st, we want to reiterate our prediction of two to three rate cuts this year, totaling 75 basis points. We also have some updated thoughts based on recent developments. Current yields for two-year and ten-year bonds are more aligned with our year-end expectations than our end-of-summer projections, and other yields are slightly lower than anticipated due to recent market volatility.
Using the Bloomberg World Interest Rate Probability (WIRP) function, we notice the market has slightly shifted toward our view on Fed rate probabilities.
We have strongly advocated for a Fed rate cut in July. This stance is supported by economic data and would divert attention from the Fed during the election heat. The election, heavily fought on social media, has shown that few topics are off-limits. I dread the idea of a September rate cut causing a stock market surge, leading to social media chaos and accusations of political bias. Whether true or not, social media often prioritizes compelling narratives over facts. It seems more senior politicians are discussing the Fed's role, influenced by today's media environment.
The data supports a July cut from both an economic and political standpoint, but after misjudging "transitory" inflation, the Fed might be overly cautious about cutting rates.
The latest jobs report alone doesn't indicate an immediate need for a rate cut. However, our analysis highlighted reasons why it was more favorable for bonds than it appeared. Key points include strong hiring in the private sector, overstated positive data likely to be revised down, and a decline in "Help Wanted" signs and fewer record-breaking union deals.
We're developing faster, more reliable data sources and have noticed some intriguing trends. The Conference Board's June HWOL Report showed a 10% decline in job postings by the end of May. BBC's report on "ghost jobs" supports the idea that many job listings are speculative. ChatGPT erroneously cited outdated data about job postings on Indeed.com, emphasizing the need for careful data validation.
We're also hearing more about the Sahm Rule Recession Indicator, which suggests a recession is near when the three-month average unemployment rate rises 0.5% above its lowest point in the past year. Currently, we're in the range for this risk, which could be a discussion point given the economic context.
Despite my skepticism about economic "rules," the Taylor Rule from the Atlanta Fed estimates rates lower than current levels, indicating potential room for cuts. However, deviations from the rule are common, so it's not a definitive guide.
Financial conditions remain "easy" according to the Chicago Fed's index, potentially justifying the Fed's current rate policy. Despite easy conditions, arguments for lowering rates include forward guidance and the impact of credit competition. There's a theory that extended periods of low or high rates can create a "magnet" effect on inflation, a concept worth considering in current discussions.
Corporate America's net interest expense is currently positive, benefiting from lower average bond coupons compared to fed funds. A rate cut could reduce cash income and slow spending, potentially being deflationary. Money market funds are injecting substantial funds into the economy. Cutting rates might reduce this influx and slow spending.
We expect a favorable CPI report, with inflation trends moving in the right direction barring geopolitical disruptions. The Covid "Bump" theory suggests inflation from goods surged earlier, while services inflation peaked later and should normalize, reducing overall inflation pressure.
We anticipate 75 basis points of rate cuts this year, though a July cut seems unlikely. Yield curves should become less inverted, and we expect tighter credit spreads and strong equity performance driven by momentum and AI.