By Serafino Tobia, Director of Agency CMBS Trading and Portfolio, Greystone
US Treasuries
After all the debate about the size of the rate cut we would see last Wednesday, the Federal Reserve Bank exceeded most everyone’s thinking by cutting the overnight Fed Funds rate by 0.50%, moving the target range for Fed Funds down to 4.75% - 5.00%. Last Wednesday, we also received a new dot plot (a forecast survey from the 19 regional Fed officials) indicating that Fed officials expect the Fed Funds rate to be 4.375% by year-end 2024 (another 50 basis points over the next 3 months), down to 3.375% by year-end 2025 (another 1% in rate cuts in 2025) and then another 0.50% in rate cuts in 2026, putting the forecasted neutral overnight Fed Funds rate at about 2.875% (of course, subject to how the economy and inflation perform).
Watch Fed Chairman Powell’s Press Conference.
This past week, the 10-year Treasury traded as low as 3.60% last Tuesday morning. After the oversized Fed Funds ½ point rate cut, 10-year yields actually moved incrementally higher over the past few days; trading in a range of 3.70% - 3.77%. That’s atypical; normally, the entire yield curve moves lower with a cut in the overnight Fed Funds rate. “Normally,” rate cuts mean that the Fed is concerned that the economy is weakening and in need of Fed intervention. This time however, the cut in the Fed Funds rate reflects the Fed’s intent to stick the landing, a “soft landing” -- lower inflation with the economy remaining strong. The FOMC statement reflects a recalibration – a focus on keeping the employment rate strong along with a confidence that we are on a disinflation path towards the Fed’s 2% inflation target. In other words, this particular rate cut was not in response to a substantially weaker economy; rather the rate cut is to safeguard a soft landing economy (a point of pride for the Fed and Fed Chairman Powell). By broad measures, a hard-landing scenario is now outside the statistical probable confidence interval:
- Inflation is improving, now at 2.5% as measured by the PCE Index, the Fed’s preferred inflation gauge. We will get another read on the PCE index on September 27.
- Yes, US employment has cooled some, but the current 4.2% unemployment rate (as of August 2024) is still healthy from a historical perspective. Job creation came in at 142,000 new jobs in August, arguably slower, but not weak by any means. The weekly jobless claims data last Thursday showed just 219,000, the lowest since May, another sign that the labor market remains healthy.
- GDP (gross domestic production) continues to be strong, +3% growth (annualized) for the 2nd quarter of 2024.
My Take on Longer Term Yields
I’ve been saying for quite some time that the longer-term neutral yield for 10-year Treasuries should be somewhere around 4% -- based on expected inflation of around 2.50%, an overnight Fed Funds rate of around 3.25% and an add-on for term risk. If you figure that inflation moves towards 2%, a 10-year Treasury yield between 3.50% to 3.75% seems about right. Therefore, with 10-year Treasury yields at 3.76% currently, at this point, even when we get additional cuts in the overnight Fed Funds rate, I’m not expecting the longer-term rates to keep pace; the yield curve will steepen. Certainly, if we see a weaker economy, the Fed will likely move quicker, and inflation expectations and longer-term rates may improve further as well.
Upcoming Economic Calendar
The highlight of the data for this coming week will be the August PCE inflation index on Friday, September 27. With August CPI and PPI data already published, economists are estimating the PCE index to come in at +0.1% for the month, +2.3% year-over-year (versus 2.5% as of last month). Core PCE (without the more volatile food and energy prices) is expected to print +0.2% on a month-to-month basis, +2.7% for the year. This data should help quell concerns about re-igniting inflation for the time being and help lower bond yields a bit as well.
This week, we will also receive data about the housing market, manufacturing, consumer sentiment, as well as income and spending data. August consumer spending data comes out on Friday morning and is expected to be higher by +0.3%, versus last month’s +0.5%. This could also get the attention of the bond market.
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