Tomorrow is the commencement of a two-day FOMC meeting. It is widely expected the Central Bank will lower the overnight rate by another 0.25%, bringing the benchmark rate down to a range of 4.25% to 4.5%. That would mark a full percentage point of reductions since September.
Rate cuts are forecasted to slow next year, a change in outlook from three months ago. Currently a total of three more rate reductions in 2025 is expected, “a meaningful change in the velocity” according to Bloomberg.
As widely discussed, inflation has held at roughly the same elevated level “for months.”
Perhaps the largest question that cannot be answered is what is the “neutral rate,” or what is the interest rate where policy neither stimulates nor weighs on the economy.
For many years it was believed it was around 2.0%. The correct answer to this question is pivotal regarding the level of long-term interest rates.
It is expected the Committee will increase its estimate to 3% from 2.9% in September. The range is wide, currently the lowest at 2.7% and the highest at about 4.6%. This is the widest range since the Fed began publishing the figures over a decade ago.
Wall Street is all over the place. It is 3.3%. No, its 4.5%. Actually, based on “official forecasts,” it is 2.4%.
The world has radically changed since 2020. Perhaps the two largest factors are the swollen and still swelling budget deficits and the collapse of yesterday’s trade structures where the West has weaponized the flow of funds and the East has weaponized the flow of product. Reliability has replaced price as the primary variable of purchasing decision.
What will be the impact of tariffs? Consensus is stating they will be inflationary. However, will tariffs be a secondary cause given how trade has already changed? The “experts” have been dramatically wrong for the last four year—perhaps 14 years. Can this be the case today?
Regardless, a higher neutral rate dictates higher long-term interest rates as investors will want to be paid for duration. It can be argued that perhaps long dated Treasuries are one of the most overvalued assets based upon current inflation, an inflation rate that has been stuck at current levels for months.
If the neutral rate is really around 4.2%, long dated Treasuries may have considerably rough sledding.
Commenting on Friday’s market action, led by longer dated Treasuries, the Treasury market sold off as the market is suggesting that there may a “hawkish cut” at the conclusion of Wednesday’s FOMC meeting. Equites were nominally weaker.
The economic calendar is comprised of retail sales, capacity utilization and industrial production, various housing statistics, personal spending/income and the a fore mentioned FOMC meeting.
Last night the foreign markets were down. London was down 0.29%, Paris down 0.76% and Frankfurt down 0.31%. China was down 0.16%, Japan down 0.03% and Hang Seng down 0.88%.
Futures are up about 0.25% as optimism is building ahead of the FOMC meeting. The 10-year is up 6/32 to yield 4.37%.
