What the Fed's interest rate cut means for the bond market
Summary
TLDRThe bond market is tense as investors anticipate the Federal Reserve's decision on interest rates, with a 50 basis point cut expected. Gil laa jany, Head of Fixed Income, discusses the potential impact of a 25 or 50 basis point rate cut and the future trajectory of the Fed's actions. He suggests that while a single cut might be seen as hawkish, the market could price in a dovish stance if future cuts are anticipated. The conversation also touches on the Fed's credibility, the normalcy of a rate cutting cycle, and the outlook for the yield curve, with expectations for it to steepen if economic growth continues.
Takeaways
- 📉 Markets are on edge as they anticipate the Federal Reserve's (FED) decision on interest rates, with bond markets showing a shift in expectations for a 50 basis point cut.
- 💭 The size of the rate cut on Wednesday could influence the trajectory of future FED meetings, suggesting a more gradual or accelerated pace of cuts depending on the framing of the decision.
- 🔄 There's a debate on whether a 25 or 50 basis point cut is more likely, with recent press reports and market momentum influencing the odds towards a 50 basis point reduction.
- 📰 The language in recent press reports was noted to be softer and less definitive compared to previous years, which may have contributed to the shift in market expectations.
- 🌟 The speaker suggests that short-term trading momentum, rather than aggressive positioning, could be driving the current market sentiment around the expected rate cut.
- 🔄 The speaker anticipates a 'normal' rate cutting cycle from the FED, contrasting with the extraordinary measures taken during the global pandemic.
- 💹 Historically, 'normal' rate cut cycles have involved a series of 25 basis point cuts followed by a pause, which could be a positive sign for risk assets like equities.
- 📈 The speaker is not convinced that the current cycle will end in an economic downturn, suggesting a potential for a leg higher in risk assets after a series of rate cuts.
- 🏛️ The FED's credibility is discussed, with the speaker distinguishing between academic and popular perceptions, emphasizing the FED's control over interest rate markets.
- 📈 The yield curve's future is expected to steepen, with the potential for long-term rates to rise alongside growth expectations and a 'soft landing' scenario for the economy.
Q & A
What is the current market sentiment ahead of the FED's decision on Wednesday?
-Markets are on edge, with the 10-year yield edging lower as bets on a 50 basis point cut keep rising.
What is the significance of the size of the rate cut on Wednesday's FED decision?
-The size of the rate cut is significant as it not only affects the immediate FOMC meeting but also sets the tone for future meetings, potentially influencing the pace of future cuts.
What could be the outcome of a 25 basis point rate cut with an emphasis on future cuts?
-If the Federal Reserve opts for a 25 basis point rate cut but hints at a more accelerated pace of future cuts, it could lead to the market pricing in a higher chance of 25 or 50 basis point cuts at subsequent FOMC meetings.
Why has there been a shift in the odds from 25 to 50 basis points for the upcoming rate cut?
-The shift is attributed to high-profile press reports that have softened the language around the expected rate cut, leading to a perception of a higher likelihood of a 50 basis point cut.
What is the role of short-term trading in influencing the odds of a rate hike?
-Short-term trading can significantly influence the odds of a 25 or 50 basis point rate hike due to momentum in the market, which can be affected by just a few basis points or large trades.
What does a 'normal' Fed rate cutting cycle look like according to Gil?
-A normal rate cutting cycle involves the Federal Reserve lowering rates after reaching a peak and inflation decelerating. Typically, this includes a series of 25 basis point cuts followed by a pause, and it usually doesn't end in an economic downturn.
How does Gil view the Federal Reserve's credibility in controlling interest rate markets?
-Gil believes the Federal Reserve has absolute credibility in controlling interest rate markets when needed, as they consistently follow through with their stated actions, despite sometimes being incorrect in their economic forecasts.
What are Gil's expectations for the yield curve moving forward after the FED's decision?
-Gil expects the yield curve to steepen, with the potential for 10-year yields or the longer portion of the yield curve to rise, possibly driven by growth expectations or a soft landing scenario for the economy.
What is the difference between academic and popular perceptions of the Fed's credibility?
-Academics view credibility as the Fed's ability to follow through with their actions and affect markets as expected, whereas popular perception focuses on the accuracy of the Fed's economic forecasts.
How does Gil interpret the recent inversion of the yield curve in the context of the expected easing cycle?
-Gil interprets the inversion as a market expectation of an easing cycle. He suggests that any further steepening of the yield curve would likely require an increase in long-term rates, possibly due to improved growth expectations or a soft landing for the economy.
Outlines
📉 Market Anticipation of FED Decision and Rate Cuts
The market is tense ahead of the Federal Reserve's decision on Wednesday, with bond markets showing signs of this anxiety as the 10-year yield dips slightly. There is a debate on whether a 25 or 50 basis point cut is coming, and Gil laa jany from Montgomery Scott discusses the potential implications of the FED's decision. The size of the cut could influence future FED meetings and market expectations. Gil suggests that even a 25 basis point cut with a hint of more aggressive future cuts could lead to a more dovish outcome than a single 50 basis point cut. The conversation also touches on the shift in market expectations from a 25 basis point to a 50 basis point cut, influenced by recent press reports that were less assertive than in the past. The discussion highlights the momentum in short-term trading and the potential for a 'normal' rate cutting cycle, which could involve several 25 basis point cuts followed by a pause, setting the stage for a rise in risk assets.
📈 Fed's Credibility and Yield Curve Expectations
The conversation continues with a focus on the Federal Reserve's credibility, particularly in light of its past forecasts and market control. Despite inaccuracies in economic projections, the FED maintains credibility in executing intended actions and influencing interest rate markets. The discussion then shifts to the yield curve, with Gil expressing his initial confidence in a steepening yield curve towards the end of 2024. He acknowledges the recent trend of steepening and suggests that further steepening would require a reflationary impulse, possibly through productivity gains or a soft landing avoiding an economic downturn. The expectation is that long-term rates might rise slightly, reflecting growth expectations, and this could be influenced by the FED's actions on Wednesday.
Mindmap
Keywords
💡FED
💡10-year yield
💡basis point
💡fixed income
💡rate cut
💡hawkish
💡dovish
💡yield curve
💡reflationary impulse
💡soft landing
Highlights
Markets are anxiously awaiting the Fed's decision on Wednesday, affecting bonds and the 10-year yield.
The debate on whether a 25 or 50 basis point cut is more likely is significant for the bond market.
The outcome of Wednesday's Fed meeting could set the tone for future meetings.
A 25 basis point rate cut with a hint of accelerated future cuts could be on the cards.
The language used in recent press reports suggests a softer stance from the Fed.
Momentum in short-term trading can significantly influence rate hike expectations.
The odds of a 20, 25, or 50 basis point cut are shifting, with 50 basis points gaining ground.
The US is expected to have a 'normal' Fed rate cutting cycle, unlike the extraordinary measures during the pandemic.
Historically, normal rate cut cycles often end in economic downturns, but this time could be different.
Midcycle corrections usually involve a series of 25 basis point rate cuts followed by a pause.
The current situation suggests we might see four or five 25 basis point rate cuts in the coming quarters.
A series of rate cuts could set the stage for a rise in risk assets like equities.
The Fed's credibility has been questioned, but it still has control over interest rate markets.
The yield curve's inversion and the expected easing cycle beginning on Wednesday are noteworthy.
The yield curve's future movement will likely depend on long-term growth expectations and reflationary impulses.
The expectation for the yield curve to steepen towards the end of 2024 has been challenged.
Any further steepening of the yield curve would realistically require longer-term rates to rise.
A soft landing or avoidance of an economic downturn in 2025 could influence long rates.
Transcripts
markets are on edge ahead of the FED
decision Wednesday and that includes
bonds the 10-year yield edging lower as
bets on a 50 basis point cut keep Rising
joining us now is Gil laa jany
Montgomery Scott head of fixed income so
we were just talking about it the big
debate right now 2550 when it comes to
the bond market does it matter the size
of Wednesday's cut well to some degree
right uh you know the uh the action what
we're going to see on Wednesday
afternoon is just one fomc meeting but
depending on how it's framed it also
casts the next few meetings in its path
as well so for sake of argument right we
could see a Federal Reserve which comes
out with a 25 basis point rate cut but
emphasizes the possibility maybe even
the probability that over time they
could cut at a more accelerated Pace I
don't think those are the exact words
they would use but were that to happen
right we'd see okay this one rate cut
done perhaps on the hawkish side but the
future would end up pricing each
additional fomc meeting with a roughly
5050 chance of 25 basis points or 50
basis points and it would end up being a
doish 25 as opposed to a hawkish 50 in
which there's a cut and a more gradual
expected path you know G another
question we were just talking to our
colleague Josh schaer about this the
odds of 20 and 25 and 50 were were
pretty evenly balanced and that now
actually a shift to 50 why that shift G
what what changed I know there were some
high-profile press reports but walk me
through why why you think that occurred
yeah so I heard you talking about the
couple of press reports that were on
Friday from uh from the the journal and
also the financial times of course read
those I will say that in comparison to
situations several years ago in which
fed officials were concertedly making a
point uh to these Publications the
language in the two press reports last
Friday seemed a lot softer it seemed a
lot more it could be this or it could be
that it didn't seem like language that
in 2022 and 2023 when the Fed was
prepping markets for super sized rate
hikes that that message that they were
sign that was a much more aggressive
tone in the Press reports so I don't
think there there's really all that much
there Beyond preparing for that
possibility you know one thing I think
that is understated in this circumstance
is that there's a certain momentum uh to
short-term trading and it only really
requires a few basis points or a few
large siiz trades to skew the odds of a
25 or a 50 basis point rate hike at a
meeting in the very near term so I think
probably what you're seeing is more
momentum rather than aggressive
positioning ahead of 50 or 25 basis
point cut for next Wednesday and you say
the US is likely to have a very normal
Fed rate cutting cycle what's normal in
your view because we've been operating
in an environment that feels very not
normal yeah yeah I mean look the last
rate cutting cycle was amidst the global
pandemic and uh you know many of us were
concerned about our own uh personal
lives at that time for for obvious
reason uh and the financial Wheels were
coming off the bus in real time at that
time there were extreme Extraordinary
Measures taking place but there have
been a long history uh dating back well
prior to the global financial crisis of
normal rate cut cycles in which the
Federal Reserve after reaching some Peak
and inflation decelerating begins to
lower rates uh unfortunately many of
those Cycles end in an economic downturn
I'm not convinced that's going to happen
this time there's certainly a chance uh
but I'm not convinced it's going to
happen typically in midcycle Corrections
the three that at least the Federal
Reserve has successfully implemented in
uh 95 in 9798 and again in
2019 have been a series of three rate
cuts each of them 25 basis points and
then a pause now I think today we start
in a circumstance in which we're much
further away from neutral interest rates
than in any of those periods so more
likely than three we get four or five
but so long as economic growth holds up
if we get four or five 25 basis point
rate Cuts in the next two to three
quarters that's a pretty healthy
situation and I think it frankly sets
the leg the opportunity for a leg higher
in Risk assets like equities on the
other side of that can you a different
question we head into this meeting um G
I'm also curious what you make of The
fed's credibility here you know it did
get dinged I'm wondering if if you think
there's kind of there's been an
improvement there what grade you would
give the
fed well I'm not a professor so I don't
grade him uh but I will say that I think
like academics talk about credibility
very differently from sort of the the
the financial media so academics would
talk about credibility as whether when
the FED says they're going to do
something do they do it does it affect
markets and is the result of that
roughly what they expect that's very
different from the sort of uh popular
perception of fed credibility which is
are they right in their forecasts and
there have been numerous times in the
last two years in which the fed's
primary forecast as distributed in the
summary economic projections the dot
plots was not right um and that's going
to be the case with any economic
forecast for sure but in terms of
whether the FED has control over the
interest rate markets when they need it
uh whether they follow through with the
actions that they say they're going to
take in a concrete way they have
absolute credibility in that sense and G
there's been a continuous expectation
that the FED is going to cut interest
rates which is part of the reason why we
saw the yield curve un invert we talk
about the yield curve all the time you
know whether or not it indicates a
recession or not since this easing cycle
is expected to begin on Wednesday what
are your expectations for the yield
curve moving forward and how should we
really look at and analyze those moves
yeah so at the beginning of this year
really the end of last year in our 24
Outlook we I published a comment that
haunts me a touch I will say that I had
greater confidence uh that the yield
curve would steepen towards the middle
to end of 2024 uh than I did in the
level of interest rates presented in
those forecasts well it took a long long
time uh but we do look like we're in a
little bit of a steepening trend here
based on how far the front end of the
yield curve uh call it the you know the
the two-year portion of the yiel curve
has fallen any more steepening from here
realistically is it going to require
10year yields or the longer portion of
the yield curve to rise and that only
really comes alongside a little bit of a
reflationary impulse I don't mean that
in terms of inflation but in terms of
growth expectations uh so we could get
that in the form of Greater productivity
gains over time uh and essentially uh
what What's been popularly termed a soft
Landing or the avoidance of an economic
downturn in 2025 and so I think that's
really the next stage
of yield curve steepening is about long
rates moving somewhat
higher well we'll see what happens on
Wednesday gilas thank you so much for
your time thank you allly
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