Anticipating the First Federal Reserve Cut

Re-evaluating Rate Predictions

As the 10-year Treasury is currently trading at the lower end of our projected range of 4.3% to 4.5%, it seems an opportune moment to revisit our predictions for rates. This comes as we process recent jobs data and look ahead to the Federal Reserve's next moves.

Political Implications of the First Federal Reserve Cut

Before delving deeper, it's worth considering the potential political reaction to the first Federal Reserve cut. The timing of these cuts in this year will likely be influenced by political factors. Presumed Republican nominee and former President, Donald Trump, is likely to argue that the Federal Reserve is handing the election to the Democrats through a politically motivated cut aimed at aiding the current president, despite failing to control inflation. On the other hand, current President and presumed Democratic nominee, Joe Biden, is likely to argue that the cut is a confirmation of the success of his economic policies, and proof that the country is in good shape. The narratives spun by both sides will resonate with different segments of the population, and this is a significant factor to consider. Personally, I would not schedule the first cut for September.

Market Predictions for Federal Reserve Cuts

Using Bloomberg's WIRP function, we can examine market predictions as of Tuesday, June 2nd. The market seems to disagree with me, as it predicts the highest probability of a cut before December to be in September. Overall, the market predicts an 80% chance of a cut before the election. I believe that the Federal Reserve wants to make a single cut as a validation of their successful policies. They have managed to slow inflation without causing a recession, and they can now start moving in the opposite direction. Regardless of what the data suggests, I believe the Federal Reserve will make a cut this year. If the data is too strong, they might not cut, but so far, the data has been ambiguous at best. I predict a cut at the July meeting. My base case is a 25 bps cut, with a possibility of a 50 bps cut if the jobs data is weak enough. I lean towards July rather than September because the cut will be far enough from the election to minimize political noise, and it will occur during the peak holiday season, reducing the likelihood of the noise being heard. Following this, I expect another 1 to 2 cuts this year, likely in November and December. I am generally in the 75 bps camp for this year, starting earlier than the market currently predicts.

Summary of Economic Projections

We can expect an updated Summary of Economic Projections at the June meeting. On the dot plot front, I expect the median to move to 2 cuts, aligning with the mean that dropped in the previous release. I anticipate that Powell will put July firmly on the table, which would also go against the dots. I also expect 2026 and the “longer run” to inch higher.

Factors Influencing Yields

There will be a multitude of factors influencing yields, including data and policy. These factors will impact yields, the shape of the curve, and more. Some of these factors include the jobs data, consumer behavior, credit trends, inflation, bond yields, competition from China and India, and decreasing demand for goods and services.

Factors Potentially Increasing Yields

Factors that could potentially push yields higher include the increasing deficit, less demand from foreign buyers, risks to commodities, and inflationary pressures from factors such as on-shoring, near-shoring, existing government subsidies, and energy demand.

Yield Forecast

In the days leading up to the Federal Reserve meeting, I predict that we could see lower yields. I expect the number of cuts to increase to 3 by the end of January 2025, and the timing of the cuts to be brought forward, with the first in July. The 10-year could potentially drop as low as 4.2%, but I would prepare for higher yields as we break through 4.3%. I also predict that the 10-year will break 5% again between now and the end of the year. Investors should take advantage of the recent bond rally, while issuers should issue whatever they need as Treasury yields and credit spreads are currently favorable.

Final Thoughts

The timing and impact of the Federal Reserve's cuts are subject to a multitude of factors, including political reactions, market predictions, and various economic influences. As we anticipate the Federal Reserve's next moves, it's essential to consider all these elements and their potential implications. What are your thoughts on this matter? Feel free to share this article with your friends and discuss. Don't forget to sign up for the Daily Briefing, which is delivered every day at 6pm.