Expectations were virtually sealed this past week for the Fed to cut its target rate by 25 basis points on Wednesday afternoon. Economic data supported this narrative but raised the specter of more pe...
Volatility was on full display this week as rates tested new cycle highs after the Trump election victory. On Thursday, the FOMC rate decision was announced calling for a 25-basis point cut followed by an “interesting” presser from Chair Powell. The bond market will get a mini break with the 3-day holiday weekend and market close due to the Veteran’s Day holiday, but the always important CPI, PPI, and Initial Jobless claims reports will be released later in the week.
Rates peaked at 4.43% in 10-Yr Treasuries on Wednesday, before the ensuing bounce on Thursday. Friday’s follow-through activity returned levels to close the week at 4.30% (within one basis point from where the week began).
Powell’s comments during the press conference set the tone for expectations from the Fed in the immediate future, along with the longer-term timeframe with a Trump Presidency. First, he was emphatic in responding with a simple, “No.” to a question about whether he would step down from his post should Trump request. He aptly pointed out that there is no legal basis for a President to push out a sitting Federal Reserve Chair. Furthermore, Powell set the tone for subsequent policy action; especially the December rate cut possibility. He specifically referenced the 3-month and 6-month core-PCE around 2.3% suggesting that progress continues to be made in fighting inflation, and bumps may be possible along the way.
As the above chart indicates, during stable or loose monetary policy periods, 10-Year Treasury rates generally exhibit a meaningful spread (in excess of 100 basis points) above the Fed Funds Target Rate. It generally takes at least 6 months for the spread to materialize following a higher rate period. However, the Fed initiated its rate-cutting stance in September, so the clock has already started. I believe the Fed will be more challenged to sustain the proposed path for the Target Rate of 3.375% by December 2025. For this reason, I expect 10-Year rates to have a difficult time sustaining significantly lower levels over the next 12 months than the current 4.25-4.50% range. Concerns about inflation returning are a primary consideration for this stance. I will keep a close watch on any efforts made by the Trump administration, especially ‘Secretary of Cost-Cutting’ Elon Musk’s stated goal to reduce federal spending by $2 trillion. Despite the obvious challenge to achieving success with this initiative in a politically charged Washington DC, I’ve learned to never count Elon Musk out. If there is concrete progress toward achieving a leaner federal budget, I will most certainly change my expectations of both the Fed and the path of interest rates.
The failure of the 10-Yr Treasury to push above the 4.50% threshold last week creates an interesting dynamic suggesting that rates may have a near-term ceiling in place. As stated above, I question the ability of Treasuries to regain meaningful lower levels in the aftermath of inflation concerns regarding Trump’s tariff and tax policies. There is an opposing camp that suggests the top is in place and yields could revisit sub-4% yields before year-end. To be fair, I can see a future with this possibility, however, my perspective suggests a continued higher-for-longer environment. Following the 2016 Trump victory at the polls, interest rates rose 80 basis points by mid-December. The Fed was espousing a tighter policy stance, as opposed to the current looser monetary policy environment, which could have some bearing upon such a move. Additionally, the market may have already priced in a move towards higher rates prior to the election, limiting further increases in yields. In 2016, there were a lot of “unknown-unknowns” regarding a Trump administration, which we are collectively more aware of the second time around. That being said, the chance that the economy experiences an inflationary environment remains a distinct probability and I expect the Fed to be challenged to continue on its previously discussed rate-cutting path.
As anticipated, SWBC clients were reserved in their buying activity ahead of the election. Markets generally shy away from uncertainty and Presidential elections typically present enough uncertainty to keep investors on the sidelines until results are known. Wednesday’s market sell-off provided limited incentive for buyers to jump into the action intra-day. By Thursday, however, the market found solid footing and investors were more aggressive in seeking opportunities to lock in the most attractive yields that have been available in the past 12 months. The extremely limited new issue calendar likely added some sense of urgency as buyers were scrambling to pursue opportunities in the secondary market. Friday saw a continuation of the prior day’s trend with buyers continuing to put cash to work. Supply will remain constrained this week, as the calendar fails to exceed $6 billion in issuance, well below the $9.3 billion average weekly supply throughout 2024.
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