It has become more difficult to forecast the Federal Reserve’s next move, or at least the timing of it. The odds of a September 18 Federal Open Market Committee (FOMC) meeting rate cut seemed to be in the bag during the volatility of August and September. Zoom forward into a major stock market rally and a reversal of the yield curve inversion. Now investors get to add a serious rise in long-term interest rates into the mix, up until the uncertainty seen in the Middle East this week.
Now the question is whether Fed Chair Jerome Powell and the voting members of the FOMC will even want to cut rates at the September 18 meeting.
One issue that has come up, and which is not all that simple to explain, is that the Fed took action with a repurchase operation (see below) to the tune of $53 billion to prevent the federal funds rate from trading outside of its range. Fed funds are supposed to be in the stated 2.00% to 2.25% range, and the odds of a rate cut now seem more in jeopardy, despite additional fresh quantitative easing measures from the European Central Bank last week.
For the second half of August and into the start of September, the CME FedWatch Tool had forecast better than a 90% probability that the fed funds rate would drop to a range of 1.75% to 2.00%. Those odds have been creeping lower in recent days, and what had been odds of 62.3% of a rate cut one day earlier (versus 92.3% a week ago) is now listed as just 49.6%.
Effectively, without being technical, the market is now giving the same odds for a rate cut as it would betting on whether a coin toss would be heads or tails.
The odds that a rate cut of some sort will be seen at the October 30, 2019, FOMC meeting remain favorable. There are 28.8% odds that the range will stay 2.00% to 2.25%, followed by 49.9% odds for a 1.75% to 2.00% range and then 21.2% of a 1.50% to 1.75% fed funds range.
While there are still some obvious risks to the economy, the trends within Google search results of “inverted yield curve” and “recession” have come way down from their peak levels in August. That’s what happens when the Dow Jones industrials rallied 1,500 points and the S&P 500 rallied over 160 points in less than two weeks.
The Federal Reserve Bank of New York announced about the repurchase efforts to keep fed funds within its target range:
This repo operation will be conducted with Primary Dealers for up to an aggregate amount of $75 billion. Securities eligible as collateral in the repo include Treasury, agency debt, and agency mortgage-backed securities. Primary Dealers will be permitted to submit up to two propositions per security type. There will be a limit of $10 billion per proposition submitted in this operation. Propositions will be awarded based on their attractiveness relative to a benchmark rate for each collateral type, and are subject to a minimum bid rate of 2.10 percent.
The huge rotation of a week earlier into value from growth may have been short-lived, and the interest that had been seen in energy last week and that was magnified on Monday after the Saudi oil attack has been met with solid profit-taking on Tuesday. With many double-digit percentage gains seen on Monday in the more speculative names being followed with similar double-digit percentage drops on Tuesday, now some of the interest may turn back to bonds and what happens with the yield curve.
Two issues may have helped rock the boat even further for a September rate cut in the form of economic numbers. There are some signs that inflation finally has perked up, and industrial production was higher, along with stronger sentiment readings from consumers and from builders alike.
While the odds of a rate cut have come down drastically, these market-based odds can change rapidly, and the odds of one day are not assured to even be remotely close the following day.
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