The Fed cut interest rates 50bps on Wednesday which means the fed-funds rate will now be in a range of 4.75% to 5%. In their policy statement, the Fed officials are forecasting higher unemployment and lower inflation than just three months ago. It is clear that the negative revisions to the June/July payroll caused a pivot to prioritizing the potential for weakness in the labor market over inflation.
The Path Forward?
This policy statement also had the ‘dot-plot’ which shows a forward projection of interest rates according to each of the twelve Fed Governors. As you can see on the adjacent graphic (WSJ), the current projections have the Fed-Funds rate going to 3% by 2027.
However, the dot-plot has a reputation for being revised rapidly if current conditions throw a curveball. Meaning, the Fed is signaling this will be the start of a series of reductions to the front end of the curve. How far it goes will depend on the strength of the economy.
Whom does it help?
Rate cuts were largely anticipated by the bond market as longer tenor debt has been falling since last October. However, this 50bp reduction will provide immediate relief to consumers with credit card balances and to small businesses with variable-rate debt.
The Yield Curve
In the chart below, we can see longer tenor bonds have been falling for months as the blue line illustrates where we closed on Friday. In the coming year, we should see the blue line flatten and then steepen which means longer tenor bonds will yield more than the Fed-Funds rate. This would create a steep yield curve which is considered ‘normalized’. However, this normalization process usually comes with an economic slowdown.
The S&P 500
The stock market has loved low interest rates and the reaction this week was a push to new all-time highs. If you read my post last week (Enter the Easing Cycle), you will know that the 161.8% FIB extension at $561 (SPY ETF) was an important technical hurdle to overcome. This is a bullish development but we need to confirm it with some follow-thru next week or maybe even a small re-test lower.
The next Fed meeting is in November and there will be a lot headlines swirling around the media but the most important thing to watch will be the jobs data as inflation looks to be contained (for now).
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President, Kisco Capital
