The Fed cutting cycle began in November 2022. You just missed it. While you’ll hear a bunch of debate about whether the Fed will raise rates “25bps at the next meeting”, or “they’ll pause!”, or “25bps now and 25bps again at the next one!”…. It all misses the point.
And look, I just did a post on hating all the “Fed speak” predictions. I’m so done with all of it. But I’ll add one more thought to the cocktail party as I recognize it drives markets.
Yes, the Fed isn’t actually cutting rates (yet). But if you are confused by market reaction right now (equities are well off the bottom and credit markets are thawing each day), it is because the market is forward looking and already started to price cuts in. In fact, no matter how hawkish Fed officials have been, rates even at the short-end refuse to budge.
October CPI came in weak. Weak enough to piece together inflation had clearly peaked.
In turn, we had a massive move in the market. The S&P closed up 5.5% that day, but more importantly, look at the yield curve:
The 10 year tightened nearly 30bps, as did the 3, 5 and 7 yr. Since then it has continued to be a dramatic difference, with the 10yr now 70bps inside.
But how else can we see this view changed exactly on that day?
The US Dollar also peaked:
Homebuilders have ripped:
Here are 3 month SOFR Spreads, which is a way to look at market expectations of future Fed policy. Big change around November, huh?
It is no different when the Fed says it will, “likely raise rates 50-75bps at a meeting” like it did in 2022. The market priced that in largely at announcement. The Fed didn’t actually have to start raising rates yet for financial conditions to tighten to that level.
Likewise, the market understands inflation is now much more in control. In fact, as I have written due to the bullwhip effect, it could overshoot to the downside with inventory glut and lower demand.
We all like to believe the market is inefficient, and I have seen inefficiencies first hand. In some cases though, it is pretty good at sniffing out the truth. It’s pieced out inflation has peaked and now is time to focus on the second mandate, employment.