Another Fed meeting this Wednesday and once again it seems that cutting rates this September is an admission they have made another policy misstep in the post COVID era. Is it fair to be this critical? Maybe. But it seems that Fed policy is consistently in the spotlight since the financial crisis as they can’t detach from the markets hinging on every policy pivot.
One thing that I don’t read much about lately is the size of the Fed’s balance sheet which remains massive despite divesting $2T worth of treasury bonds since 2022 (see graph below). Quantitative easing (when the Fed buys bonds) acts like a rate cut so when the Fed does move the Fed Funds Rate (up or down) it acts like a wet blanket and mutes the Fed’s ability to achieve its more immediate goals like tamping down inflation to 2%. It is a shame that there was not a more aggressive divestiture program when t-bills were yielding 5% as the world was gobbling up that paper like there was no tomorrow.
That window to easily divest is now closed so in 2025 the Fed is left with cutting rates before their inflation busting goals are achieved. Adding to the pile of considerations is that the labor market has recently waned as evidenced by the negative revisions to the payroll data.
Let’s Review This Week’s Data
Several items of significant data were released this week and it is worth reviewing before we hear from the Federal Open Market Committee (FOMC) and Fed Chair Jerome Powell.
- The Bureau of Labor Statistics (BLS) released their annual preliminary annual benchmark revision to nonfarm payrolls which showed job creation was 911k less over the 12 months through March 2025. This adjustment implies average monthly gains of just 71k during this period which is far below the 150k consensus. While benchmark revisions average 0.2% over the past decade, this one’s magnitude of 0.6% highlights how rosy the headline jobs numbers may have been. The revisions bolster the disinflation story but raises recession risk if hiring momentum doesn’t rebound.
- August PPI (Producer Price Index) brought a welcome surprise, falling 0.1% month-over-month against forecasts for a 0.2% gain. The annual rate decelerated to 2.6% from 3.1% in July. This shows companies are absorbing some tariff-related costs.
- August CPI (Consumer Price Index) came in hotter than expected as headline CPI rose 0.4% month-over-month and 2.9% year-over-year—the fastest annual pace since January. This rebound, amid sticky services inflation, dims hopes for a seamless disinflation path and could tilt the scales toward a more hawkish Fed tone this week.
- The 30YR mortgage rate dropped to 6.49% from 6.64% which stimulated purchases and refinancing – purchase apps rose 6.6% and refi’s were up 12.2%.
- The Labor Department reported initial jobless claims for the week ending 9/6 rose to 263k — the highest level since October 2021. This may be an early indicator of broadening layoffs across sectors like manufacturing and retail.
What To Expect On Wednesday
The baseline expectations is that the Fed will deliver a 0.25% cut to the Fed Funds Rate at 2PM on Wednesday. However, after this week many market pundits are calling for 50bps and there is a growing consensus that there will be 75bps of cuts by the end of 2025. The data this week was significant and should weigh on the Fed’s deliberations on how to guide the market for the remainder of the year.
The Fed will also release its statement on economic conditions and the updated Summary of Economic Projections (SEP). The SEP includes forecasts for key economic indicators such as GDP growth, unemployment rates, and inflation. This meeting will also feature the dot-plot where each voting member anonymously provides their projection on the future path of interest rates.
The S&P 500 Chart
Stocks liked the data this week as net/net it means lower interest rates. The S&P pushed above the orange trend-line and I think we may see a continued rise up to the yellow line at 6975 in the coming weeks if the market likes the Fed’s message on Wednesday. The technical indicators at the bottom of the chart are not warning of anything negative so we will have to wait and see how the market reacts in the days following Wednesday’s meeting.
The Shape of the Yield Curve
The belief of the curve (2-5Yrs) has been predicting more rate cuts for weeks now. As you can see, the left side of the curve is where t-bills trade and these rates have fallen over the past three months in anticipation of more rate relief. Notable is that 30Yrs have NOT followed longer tenor bonds and sticks out like a sore thumb (also known as ‘the knob’).
The bond market has taken it as a foregone conclusion that the left side will fall but will 10 thru 30Yrs remain high as the Fed has fallen short in achieving its 2% target? Investors going long on the curve will need to be compensated for higher inflation levels so that will be the next item bond traders focus on as we head towards 2026.
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Paul J McCarthy III CFA
President, Kisco Capital
