Macroeconomics

Fed surprises, markets disappointed

19 September 2024 • 3 mins read

US Federal Reserve Chair, Jerome Powell. AFP.

The Federal Reserve (Fed) surprised by starting its rate cutting cycle with a 50bps reduction in its fed funds rate from 5.25-5.50% to 4.75-5.00% rather than with a widely expected 25bps move.
Chairman Powell justified the decision by arguing it showed the Fed would not fall behind the curve as the labour market slowed and as officials were confident inflation would reach the Fed’s 2% goal.
However, after first trading positively, the S&P 500 Index fell 0.3%, gold ended lower, 10Y US Treasury (UST) yields rose to 3.70% and the USD firmed to 143 against the JPY.
The reaction was due to the Fed’s new forecasts implying only 25bps cuts in future. We thus keep our view the Fed’s easing cycle may disappoint investors and stay neutral on fixed income.

The Federal Reserve surprised by starting its interest rate cutting cycle with a 50bps reduction in the fed funds rate from 5.25-5.50% to 4.75-5.00% rather than with a 25bps move widely expected by investors.

Chairman Powell justified the decision by arguing it showed the Fed would not fall behind the curve as the US jobs market slowed: ‘the labour market is actually in solid condition, and our intention with our policy move today is to keep it there … we don’t think we’re behind. You can take this as a sign of our commitment not to get behind.’

The Fed Chair also said the 50bps rate cut reflected officials’ ‘confidence that inflation is coming down toward 2% on a sustainable basis.’

However, after first reacting positively to the larger-than-expected ate cut, the S&P 500 Index fell 0.3% overnight, gold ended lower too despite initially making a new all-time high of USD2,600, 10Y UST yields rose to 3.70% and the USD firmed to 143 against the JPY.

Financial markets fell as the Fed’s updated forecasts implied the fed funds rate would only be lowered in 25bps moves going forward.

The median projection from the Federal Open Market Committee (FOMC) showed the fed funds rate ending 2024 at 4.25-4.50%, and thus signalled two 25bps cuts in November and December. Similarly, the forecasts implied four 25bps cuts in 2025 and two in 2026 to lower the fed funds rate to 2.75-3.00%.

Source: Bank of Singapore, Bloomberg

The chart shows officials thus only projected the fed funds rate to gradually reach neutral levels near 3% over the next couple of years. We therefore think:

The Fed is likely to cut rates still in 25bps moves in November, December, January and March as we had earlier expected. We thus see the fed funds rate at 3.75-4.00% over the next six months.
Further cuts beyond March may be limited to 25bps a quarter until the fed funds rate falls to a neutral level of 3.25-3.50% but may not occur if former President Trump wins in November.
We keep our view the Fed’s easing cycle may disappoint investors. We stay neutral on fixed income, favour bonds with shorter-term maturities over longer-term issues and forecast 10Y yields will trade back above 4.00% as we see no US recession and as a new president may follow more inflationary policies in 2025.

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Author:

Mansoor Mohi-uddin

Bank of Singapore