Fed Chair Jerome Powell tried to push back on near-term rate cut expectations, but markets shoved right back. Pricing suggests markets are concerned that if the Fed waits too long to cut rates policymakers will only have to cut them more.
February 1, 2024
Thomas Garretson, CFA
Senior Portfolio StrategistFixed Income StrategiesPortfolio Advisory Group – U.S.
What was widely expected to be a rather uneventful first Federal Reserve
meeting of the year proved to be anything but. Though heightened market
volatility around it may have been amplified by other events this week,
the Fed’s relative reluctance to formally open the rate cut window sparked
some interesting market reactions.
While most would probably argue that the Fed was a bit late to the rate
hike party in 2022, the underlying risk for markets – and the economy – is
that it could also be late to the rate cut party. To be sure, Powell this
week acknowledged the risks of cutting too late, especially as
inflationary pressures have receded more rapidly than policymakers had
expected late last year. But the market reaction this week suggests that
risk remains – if not even more elevated.
Powell’s comments were successful in culling market pricing of a March
rate cut with probabilities fading to roughly 30 percent from a peak
closer to 90 percent in January. But markets simply took that and ran with
the idea that a later start to rate cuts might only mean that a greater
number of cuts are ultimately needed. Prior to Powell’s comments, markets
were pricing in about five 25 basis point rate cuts to around 4.1 percent
by the end of the year; now markets are pricing deeper cuts to around 3.8
And this dynamic is pressuring Treasury yields lower. The benchmark
10-year Treasury note yield has faded to just 3.8 percent (in line with
rate cut expectations) from a 2024 peak of 4.2 percent achieved one week
ago, and notably down from the 2023 high of five percent. A break below
3.8 percent would mark the lowest level since this past July.
The line chart shows the expected level of the U.S. federal funds
rate, relative to the current 5.3%, in the fourth quarter of 2024,
according to four sources: the Federal Reserve’s own projection
(4.6%), Bloomberg consensus (4.3%), RBC Capital Markets (4.1%), and
the projection based on current market pricing (3.8%).
Source – RBC Wealth Management, Bloomberg; data as of 2/1/24,
forecasts shown for Q4 2024
We would be the first to concede that getting a clean read on the market’s
interpretation of the Fed meeting this week was certainly clouded by
market stress elsewhere. Specifically within regional banks as New York
Community Bancorp’s (NYCB’s) stock price fell by half following its Q1
earnings report where the dividend was cut by 70 percent.
A drop of that magnitude sparked broader selling pressures within the
regional banking sector, raising investor concerns that the ghosts of
banking stress that visited markets last spring could be coming back to
However, our early read is that this is a localised event and not a
harbinger of another round of broader regional banking stress on par with
what markets weathered last year. RBC Capital Markets analysts noted:
“Results had several negative surprises, including a higher-than-expected
provision and reserve build, a meaningfully lower margin and outlook, and
a dividend cut announcement. We believe that many of these trends are
related to the company crossing the $100 billion asset mark and becoming a
Category IV financial institution, which is driving increased liquidity
and compliance needs, though in aggregate the results were less than
expected. The 2024 outlook also suggests some further margin and expense
pressures due to these themes.”
Turning back to the Fed and where things might go from here, we think
inflation is still the name of the game. This is perhaps also where the
greatest disconnect between Powell’s comments and current market sentiment
We think the clear takeaway is that the Fed still wants even more
evidence, and greater confidence, that inflation is on a firm path back to
two percent. In our view, it is. Core Personal Consumption Expenditures
Inflation (excluding food and energy) has been running below the Fed’s
two percent target over the past three and six months, at 1.5 percent and
1.9 percent annualised, respectively. While Powell somewhat dismissed
those numbers and fell back to highlighting the year-over-year pace at a
still-elevated 2.9 percent, we do think the Fed is closer to the point of
declaring victory than policymakers are letting on. We remain highly
certain the Fed won’t wait until annual inflation is back to two percent,
as by then it would be far too late. Markets perhaps just wanted more
acknowledgment of recent inflation progress.
Other data released this week showed another sharp drop in consumer
inflation expectations. As shown in the last chart, one-year inflation
views have almost unwound all of the rise over the past two years, and are
now in line with historically standard levels.
The line chart shows, for the period of 2014 to January 2024, the
deviation of consumer inflation expectations over a one-year time
horizon from the median level over that period. The deviation was
largely negative by 0.5% or less until mid-2020, when it suddenly rose
to 1.5% above the median. Consumer expectations reached a maximum of
almost 3.5% in mid-2022, and have since trended downward to 0.1% in
Source – RBC Wealth Management, Bloomberg, Conference Board Consumer
Confidence Survey; monthly data, 12/31/14–1/31/24
The Fed’s goal of approaching the “highly consequential” decision to begin
cutting rates “methodically and carefully,” as various policymakers have
recently suggested, may seem prudent on the surface, we – and the
market – clearly want a more deft and flexible approach if the Fed is going
to pull off a soft landing for the economy. We think the Fed will get
there, even if it has stumbled out of the gate.
We think there is 50 percent chance a March rate cut will occur based on
the incoming data, but, at a minimum, the meeting will likely set the
stage for a May cut, with more to follow this year.
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