The two-year Treasury yield—or the instrument most sensitive to monetary policy—climbed to its highest levels since early December as expectations for Federal Reserve interest rate cut this year continued to erode, with the market dropping the odds of a June rate cut to less than 50%.
As previously discussed, Fed policy makers are slated to conclude a two-day meeting on Wednesday. While expected to leave the target band unchanged, they will make new quarterly forecasts for the economy and monetary policy.
The lates ones, from December, anticipated three quarter point rate cuts this year. Since then, higher than expected inflation readings have stoked speculation that the new median forecast will be less dovish.
Goldman Sachs tweaked their view yesterday as they are now expecting only three-quarter point interest rates cuts this year instead of four because of higher-than-expected inflation.
Yields on longer maturity debt also increased causing the yield curve to nominally steepen.
Equites—specifically mega size cap shares—were unfazed about the rise in rates.
In theory, a stock price represents the discounted current value of its estimated future earnings. One purchases a company because you want a share of its future profits (as either dividends or a higher share price).
But that’s theory. In reality, many people buy simply because they think the share price will keep rising as other people buy. It’s a kind of “greater fool” method that can work for a period, the length of which is entirely unquantified, hence the well-known statement “the market can remain irrational one day longer one can remain sane or solvent.”
As with other assets, low interest rates magnify the profit opportunity. Cheap financing helps, whether purchasing a home or a stock. Conversely, high interest rates reduce the potential gains.
The market is also forward-looking. It responds not just to current interest rates but also to where it thinks rates are going. On that basis, the last six months could be partially justified if one really believed the overnight rate would be 150-175 bps lower in 9-12 months thus tech issues began to rally relentlessly commencing in November.
Change is the only certainty. What has changed however is the velocity of change.
Last night the foreign markets were mixed. London was down 0.24%, Paris up 0.20% and Frankfurt up 0.08%. China was down 0.72%, Japan up 0.65% and Hang Seng down 1.24%.
Dow and NASDAQ futures are flat and down 0.50% ahead of the commencement of the two day Fed meeting, oil around yearly highs and interpretation of NVDA’s first annual AI conference. The 10-year is up 3/32 to yield 4.32%.
