The Fed held their policy meeting on Wednesday and kept rates unchanged which was expected. However, their forward guidance changed significantly when reviewing their dot-plot which is a survey of each voting member’s projection of interest rates. What changed in the dot-plot was a cut in the Fed Funds Rate in 2024 from -100bps to -50bps. This means the Fed Governors are concerned inflation is becoming sticky and will take longer to subside – meaning, higher rates for a longer period of time. It also means that a soft landing, which has never happened, remains a unicorn.
Long Bonds on the Move
This guidance by the Fed was not a total shock to the bond market. As you can see below, I have a chart of 10Yr Treasury yields and they have been moving higher for over three years. Using a Fibonacci extension, it is not a stretch to see the 10Yr hit the yellow line at the top of the chart at 5% in the coming months.
Inverted Yield Curve
The current shape of the yield curve has been inverted since Q4 of last year and this signals a recession within 12-18 months of the origin date. This window is now approaching and on the horizon. As you can see below, the long bonds have been flattening the curve and eventually they will yield more than the Fed Funds rate (EFFR) on the left side of this chart. Until this week, most investors assumed this would happen via rate cuts next year. However, the Fed looks to be anchored at this rate level so longer tenors may just rise to the top of the chart to compensate for the reality of a longer fight with inflation. Hence, ending the inversion but also causing additional stress to real estate and corporate debt markets.
The Stock Market
This will all be bad news for the stock market if 10Yrs begin trending above 5%. Remember, the market topped 18 months ago and this rebound over the last 10 months may have failed in re-establishing the uptrend. If true, there may be a lot more to go on the downside.
Looking at the above chart, you can see on the far right that we have sold down for three weeks in a row and we did close slightly below the support level from August of 2022 (not good). So, the selling is likely to continue into next week and you can also see on the bottom of the chart that the momentum indicators are showing a cross to the downside. There is a quarter/month end next Friday so I wouldn’t be surprised to see a relief rally to close out next week but I doubt that will create a lasting bottom.
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President, Kisco Capital