CAMS Weekly View from the Corner - Week ending 7/19/24
July 22, 2024
Expectations of the Federal Reserve cutting their Fed Funds rate in near-term meetings are growing rapidly. This took on a new intensity via the most recent update of the Consumer Price Index (CPI) which reflected the first month-over-month negative reading since the beginning point of this price inflation era - circa early 2021.
The negative read highlighted the activity of the previous few releases whereby each month-over-month print came in slightly less than the previous month and hence a downtrend in price inflation - via CPI and the month-over-month view - has formed. That’s the month-over-month storyline. Below we broaden out to our typical timeframe of a year-over-year view.
Above is the CPI measure dating back a decade for some perspective. Our red box highlights the fact that we have been stuck in this low to mid-3% range for the previous year. Our red horizontal line highlights how this level - albeit far off the peak highs - remains the highest level we have experienced in the previous decade.
The aforementioned month-over-month downtrend has begun to have an impact on the year-over-year results as it is now at the bottom of the range of the previous year and is threatening to finally push lower. If this continues CPI will finally be delving into the 2% range for the first time in three-plus years.
Chairman Powell has offered in various statements - some of which we have quoted in previous editions - that the Fed will not wait for 2% price inflation to be achieved before they begin cutting interest rates.
With the Chairman’s view coupled with the most recent CPI results as well as some weakening economic data various markets and their participants have chimed in heavily with the view rate cuts are coming soon.
Interest rate traders have dramatically increased the probability of Fed rate cuts in particular for the slated September meeting. The CME FedWatch tracks the probabilities of changes to the Fed Funds Rate as implied by the 30-Day Fed Funds futures.
These rate probabilities are published for each of the slated Federal Reserve meeting dates. The upcoming July meeting offers a certainty of no rate cut.
The above though depicts the slated September meeting which offers a tremendous increase in rate cut expectations to now registering a 94% probability of a ¼% cut.
To be fair we had seen rate cut expectations increase notably along the path of this price inflation era under the misguided narrative assumption that price inflation was defeated. That did not pan out and with it rate cut expectations vanished into the ether.
As shared above price inflation has changed its behavior on the month-over-month view and with this developing downtrend it is beginning to show up on the year-over-year results as well.
This is the best price inflation characteristics we have seen in this era unlike in previous times when said narrative operated heavy on assumption and little on actual data, forward looking data and general proof of such.
As offered the CME FedWatch tool offers interest rate trader probabilities for each slated Federal Reserve meeting. Above represents the following meeting from our first CME FedWatch chart which is in early November.
As it stands currently it is basically a 60/40 view that rates will be cut again at that meeting by ¼% as well. If both occur we will see a ½% reduction in the Fed Funds Rate by early fall season.
What could go wrong?
Two words - price inflation.
The above data and comments on price inflation are reflecting the developing trend attempt for price inflation to move notably into the 2% realm on a year-over-year basis. This is not a certainty.
In addition, looking around the economic corner a bit it is not a certainty how price inflation will behave months downstream with rate cuts. This is where it will get real interesting for markets generally and certainly for the everyday citizen in particular who lives the price inflation experience.
This would not be the first time in our history that it appeared price inflation was beaten and rates cuts followed only to realize price inflation was not beaten and rate cuts turned back into rate hikes. The process, historically speaking, wreaked havoc through markets and socioeconomic pain for the citizenry.
The 2 Year
The U.S. Treasury 2 Year note yield is a bond market participant driven yield (think interest rate) that historically acts as a sensitive gauge relative to what these participants expect of near-term Fed interest rate policies. They often lead the trend, regardless of direction, of Fed interest rate policy direction.
Importantly, they do not always get it right in terms of their timing.
When they collectively feel the Fed will begin rate cuts they begin to bid up the price of these 2 Year Notes. They do this believing these will be the highest interest rates they will be able to garner in this cycle in light of their collective downstream view that a rate cutting cycle will begin near-term.
Through this they push the yield down on the 2 Year Treasury note instrument buy collectively bidding up the price in anticipation of what is to come – think lower interest rates. When the price of a Note or Bond rises its yield (think interest rate) moves lower in the process. Price and yield have an inverse relationship – one up the other down.
Above is the 2 Year Treasury note for the previous year. As offered and experienced in this previous year these participants do not always get their timing right relative to expectations of interest rate policy shifts.
Our first red downtrend arrow (left side) highlights the tremendous drop in yield (as they bid up the price for this instrument) with clear expectations in latter 2023 that rate cuts were coming via the aforementioned misguided view that price inflation was defeated.
Our second red arrow depicts their “oops” moment and their about face on trend as these collective participants realized they were ahead of themselves on their rate cut expectations.
More to current day our blue down arrow depicts the rapid drop in July as price inflation data has come in as described previously along with economic data that has been generally weaker.
The two together has resulted in the CME FedWatch screens shared above, the action in the above 2 Year Note as well affirming action in other areas across markets.
The bottom line is there has been an intense response across markets that rate cuts are coming soon. As offered in our two previous editions, the second half of 2024 offers to be quite interesting which has already lived up to its billing and we are not even out of July yet.
The above is just one more area of focus to add to the long list of scenarios that underpin this second half will surely prove historically noteworthy on many fronts.
I wish you well…
Ken Reinhart
Director, Market Research & Portfolio Analysis
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