Short and sweet this newsletter this week because we have a rate cut on Wednesday and will dig in more deeply on Thursday’s webinar. Speaking of webinar, remember just two weeks ago when I started the newsletter with this absurd headline from Atlanta Fed President Raphael Bostic? Here’s the image capture.
Well, Raphael made headlines again on Wednesday. Now we know why he was still talking about no cuts this week…
Whooops…
This Week This Morning
- 10T: 3.65%
- 2T: 3.58%
- SOFR 5.35%
- Term SOFR 5.08%
- Remember, this moves ahead of the actual Fed meeting once we get within a month of a rate change (since the contract is for one month)
- CPI and PPI came in so benign I don’t even need to talk about them
- The ECB cut rates again and inflation hasn’t reaccelerated because that’s not how inflation works
The Fed is Not Cutting 50bps
Markets have a 47% chance of a 50bps cut, but that’s not happening. Here’s how I know.
- There’s really been only one comment about larger cuts being on the table. They would have sent more signals by now.
- The Fed is in the black out period, so they would have to leak a story to the WSJ to change that now. If that happens, then I will change my mind.
- A 50bps cut is an admission of being behind the curve and we know how slow they are to admit they are wrong
- Cuts > than 25bps are for when the wheels are falling off
- The jobs report was pretty weak, but not weak enough to compel a 50bps cut
- Why mess with the election optics
- Powell will want a unanimous vote for the first cut
- Did I mention that a 50bps cut would be an admission of guilt and how unlikely they are to do that?
I believe they should have cut 50bps by now, starting with 25bps at the last meeting. But I don’t think they should kick off an easing cycle with a big move unless the wheels are falling off. The wheels are not falling off.
More important than 25bps or 50bps this week will be the projected path for the next 15 months. That will largely come from the updated Summary of Economic Projections (SEP), aka the blue dots.
The Fed only updates these projections every other meeting, which means the last update was June 12th.
On June 12th
Unemployment was 4.0% and the Fed was projecting it would not change for the rest of the year. Plus, they only projected a small tick up 0.2% next year to 4.2%.
- We are at 4.2% right now (and hit 4.3% last month)
Core PCE was 2.6% and the Fed was projecting it would not change the rest of the year. Plus, they only projected a small tick down 0.3% next year to 2.3%.
- We’re at 2.6% right now
- Less important than whether it goes to 2.3% or 2.0% is the fact that it’s not going above 3%
Given those year end projections, the Fed was projecting just one cut this year. That will obviously turn out to be incorrect, just like their unemployment rate and inflation forecasts.
Bloomberg’s Anna Wong pointed out that 14 out of 19 FOMC members saw unemployment at 4.0%-4.1% by year end, with another 2 members projecting even lower. That means 16 out of 19 FOMC members must have been surprised by the surge to 4.3% last month.
And if they were surprised, doesn’t that imply they must increase the number of cuts?
Fed officials now have a conundrum.
- Slow walk the unemployment projections higher, making them look like bad forecasters, but justifying a 25bps cut this week
or
- Immediately jump to 4.4% year end unemployment projection, which makes their forecasts look realistic but then suggests they should be cutting 50bps
I think they are locked into the 25bps cut, which suggests they’ll accept the egg on their forecasting face and later claim, “the data changed, so we changed.”
I think the Fed should cut 50bps, but don’t believe they will.
I also don’t believe the formal projections will suggest future 50bps cuts, but I do believe Powell will use the press conference to keep that door open.
Rates
Let’s pretend that for the first time in history the Fed’s projections turn out to be accurate. Unemployment doesn’t change for the next 15 months and Core PCE doesn’t get dragged lower by the laggy shelter component.
The Fed was projecting cutting to 4.1% by year end 2025 without any economic deterioration.
That strongly suggests they will have to update their forecast to sub-4% by year end next year. The market already expects cuts to sub-3%, so the Fed has some catching up to do.
- assuming they cut 3x this year, that put Fed Funds at 4.5% - 4.75%.
- even if they only cut at every other meeting next year, that puts Fed Funds at 3.5% - 3.75%
In that light, doesn’t that June 4.1% projection look pretty stale? And I think 3% is far more likely than 4%. But what about fixed rates? The T10 seems unlikely to break above the resistance level of 3.72%-ish unless:
- the data starts coming in stronger
- either party sweeps the WH and Congress
The low end of the technical range is 3.35%. I can’t imagine we break through that without the wheels really falling off (eg, unemployment surging towards 5%). The T10 might be range-bound for a considerable amount of time.
If I am right about the 25bps cut, and if the Fed doesn’t dramatically add in more cuts, I think the market might be a little disappointed by the first cut. I wouldn’t be surprised to rates bump back higher after the meeting.
I would strongly consider buying a cap ahead of the Fed meeting and locking in the current forward curve.
The long end of the curve will be less impacted.
The Week Ahead
Duh.
