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.