The Fed and markets seemed to be on different pages, with Fed policy statements sounding balanced while markets were fully tilted toward expectations for multiple rate cuts through the end of 2020.
In July, the Fed did what markets had been pushing for when it cut the federal funds rate by a quarter percentage point. But rather than calm the markets, the Fed only added to the concern when it did not send a clear message that there were more cuts to come.
Advocates for more rate cuts maintained that the Fed was not giving enough credence to uncertainties surrounding the trade war and slowing global growth, and, besides, they argued, inflation was in check. What’s more, the inverted yield curve was at that time flashing red signals for an impending recession.
The Fed and markets seemed to be on different pages, with Fed policy statements sounding balanced while markets were fully tilted toward expectations for multiple rate cuts through the end of 2020.
Fast forward a few months and monetary policy seems to be in a vastly different and much more normalized landscape.
As the yield curve has shifted lower …
Source: Bloomberg
The spread has turned positive…
Source: Bloomberg
The Fed’s careful balancing act of making insurance cuts to guard against global economic headwinds and normalize the yield curve without committing to extended cuts seems to have now gained acceptance with the markets. The entire yield curve has shifted lower since the July meeting because of the three rate cuts made this year.
But the moves on the short end have been significant and the curve is sloping upward again in nominal terms. (Real rates, though, still remain inverted.) The spread between the 3-month and 10-year rates was plus-37 basis points as of Nov. 7 compared to its low point of the year at minus-51 basis points on Aug. 27 – an 86 basis-point swing in less than three months.
As recently as August, Fed funds futures pricing indicated that markets expected another four cuts through the end of 2020 despite the Fed’s wait-and-see position.
Even though the Fed has subsequently delivered on two of those, in the October meeting the Fed committed to no further cuts unless there was a significant deterioration in the Fed’s future economic outlook. Markets seemed to have taken this in stride with the policy announcement passing without the market uneasiness that had tended to follow the previous two meetings. The Fed may have at last succeeded at reigning in market expectations for its policy moves.
Fed funds futures still suggest market expectations for one more cut by the end of 2020 but given the uncertainties around economic growth and the Fed’s promise to “act as appropriate” if stresses mount, this market view might not be all that far out of sync with the Fed’s stance. This, together with the more normalized yield curve, can be counted as a win for the Fed over the last month.
