Markets Are Screaming Rate Cuts. It's Fed's Turn to Respond
(Bloomberg) -- Investors’ growing conviction that the Federal Reserve will lower interest rates in coming months is putting policy makers under scrutiny when they attend what’s billed as a listening event Tuesday.
With financial markets discounting at least two quarter-point Fed interest-rate cuts by year-end -- one more than the case just days ago -- the Fed’s conference on policy strategy, tools and communication in Chicago will be closely watched. If Fed Chairman Jerome Powell, who gives opening remarks Tuesday, wanted to counter the quickly emerging consensus about easing, he has a platform to do so.
“We now see a base case in which the Fed will reluctantly cut rates three times starting in September,” Krishna Guha and Ernie Tedeschi at Evercore ISI wrote Monday. “Though we do not think the FOMC has yet reached this conclusion and there remains a substantial possibility it will get away with keeping rates on hold.”
One Federal Open Market Committee voter, St. Louis Fed President James Bullard, has already effectively endorsed the market’s take, saying Monday that a rate cut may be needed “soon” amid the trade war.
Bullard’s comments gave an extra kick to the rally in Treasuries, sending two-year yields to their lowest level since December 2017 -- down by more than a quarter-point since the middle of last week. Some of the recent gains eased in Tuesday trading, though both two-year yields, at 1.83% and 10-year ones, at 2.10%, are below the Fed’s policy rate.
“The market is increasingly convinced the Fed will cut,” Mark Cabana, Bank of America Corp.’s head of U.S. interest-rate strategy said via email. “The only question is how soon, and by how much.”
Anything Powell or Vice Chairman Richard Clarida, who’s scheduled to speak Wednesday, have to say on the outlook could affect that. Board member Lael Brainard is set to moderate a panel Tuesday. While the program doesn’t lend itself to comment on the immediate outlook -- it’s described as “a Fed listens event” -- it does offer a timely opportunity to recalibrate expectations ahead of the Fed’s June 18-19 policy meeting.
Meantime, it’s been the bond market that’s recalibrating. And not just Treasuries. Yields in the euro area also broke new ground Monday, with the rate on 10-year German bunds briefly falling to a new record low of minus 0.219%.
President Donald Trump’s Friday move to slap tariffs on Mexico meant “the dam broke” for economists who had been hesitating to join the market in anticipating Fed rate cuts, Goldman Sachs Group Inc.’s Jan Hatzius and his team said. China’s Saturday announcement on retaliatory tariffs on U.S. imports helped ignite Monday’s rally, and a report showing weakness in American manufacturing added to the grim mood.
The outperformance of two-year Treasuries relative to 10-year notes over the past week increased the yield premium of the longer note over the shorter one to as much as 25 basis points on Monday, the most in month, in a move known as “bull-steepening.” Investors monitor the yield curve for its reliability in predicting recessions.
“Bull-steepenings generally take place when the market starts to see the risk of recession prompting the Fed to act,” said Seema Shah, a global investment strategist for Principal Global Investors. It “reflects the rush of negative sentiment over the weekend which, if it isn’t arrested by positive developments on the trade front, has the potential to take the market much lower.”
If the Fed cuts, expect at least 75 basis points of easing, Scott Minerd, chief investment officer of Guggenheim Partners, said on Bloomberg Television. But he also said Treasuries are starting to look like they’ve risen too far. JPMorgan Chase & Co. strategists had a similar take, slashing their Treasury yield forecasts in recent days yet warning investors not to chase the latest rally for now.
By contrast, investing superstar Stan Druckenmiller is piling in. He said he could see the Fed funds rate going to zero in the next 18 months if the economy softens.
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