What the Fed's interest rate cut means for the bond market

Summary

The 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

00:00

📉 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.

05:03

📈 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.

Keywords

💡FED

The Federal Reserve, often referred to as the FED, is the central banking system of the United States. It plays a crucial role in setting monetary policy, including interest rates, which significantly impacts financial markets and the economy. In the script, the FED is central to the discussion as market participants anticipate its decision on interest rates, which could be a cut, affecting bond yields and investor sentiment.

💡10-year yield

The '10-year yield' refers to the yield on a ten-year U.S. Treasury note, which is a benchmark for long-term interest rates. It is a key indicator of investor sentiment and market expectations about inflation and economic growth. In the transcript, the 10-year yield is mentioned as 'edging lower,' indicating bets on a rate cut by the FED, which influences the bond market.

💡basis point

A basis point is a unit of measure used in finance to describe the percentage change in the value or rate of a financial instrument. One basis point is equal to 0.01% or 1/100th of a percent. In the context of the video, a discussion about a '50 basis point cut' refers to a significant change in interest rates, which is a substantial move by the FED and is closely watched by investors.

💡fixed income

Fixed income refers to a type of investment, such as bonds, where the borrower or issuer is obliged to pay the investor a fixed amount of interest over a specified period. In the script, Gil laa jany from Montgomery Scott, who is identified as the head of fixed income, discusses the implications of the FED's decisions on the bond market, which is a key component of fixed income investments.

💡rate cut

A rate cut refers to a central bank's decision to reduce interest rates, which can stimulate economic activity by making borrowing cheaper. The script discusses the anticipation of a rate cut by the FED, with market participants debating the size of the cut, which could be 25 or 50 basis points, and the implications for future monetary policy.

💡hawkish

In financial markets, 'hawkish' refers to a stance favoring higher interest rates and tighter monetary policy to combat inflation. In the transcript, there's a discussion about a 'hawkish 50' basis point rate cut, which implies a more aggressive move by the FED to tighten monetary policy, contrasting with a more cautious or 'dovish' approach.

💡dovish

Conversely, 'dovish' indicates a preference for lower interest rates and easier monetary policy to stimulate economic growth. The script mentions 'dovish 25' to suggest a more moderate rate cut by the FED, which would be less aggressive than a 'hawkish' cut and might be seen as supportive for riskier assets.

💡yield curve

The yield curve is a graphical representation of the interest rates on debt for a range of maturities. It is used to analyze the direction of the economy and predict future shifts in monetary policy. The script discusses the yield curve's inversion and its implications for market expectations and potential economic recessions.

💡reflationary impulse

A reflationary impulse refers to economic policies aimed at stimulating growth and increasing inflation. In the context of the video, a reflationary impulse could lead to higher long-term interest rates if there are expectations of stronger economic growth or inflation, which could influence the shape of the yield curve.

💡soft landing

A soft landing in economics refers to a scenario where an economy slows down without falling into a recession after a period of growth. The script mentions the possibility of a soft landing or avoidance of an economic downturn, which would likely affect long-term interest rates and the overall economic outlook.

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