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When it comes to interest rates, Wall Street is more confused than a reality TV star on Jeopardy!
The market expects the Fed to cut interest rates six times this year, which is a head-scratcher considering the continued strong employment numbers, rising wages and record holiday retail sales we’ve seen recently. It is highly unlikely that the Fed will lower rates that many times unless there is a major event that sends the economy careening.
The central bank will not cut rates simply because it has stopped raising them. (Keep in mind that zero or near-zero interest rates are not the norm.) And Fed Chair Jerome Powell won’t send interest rates back down just because inflation has slowed. He’ll need to see an economic downturn.
Lowering rates without a recession would fan the flames of inflation again, and Powell does not want to go down in history as the Fed chair who allowed inflation to return.
And while a recession certainly could occur, there are no signs that it will. So even if we do see a recession in 2024, it will be later in the year – too late for the Fed to squeeze in six rate cuts.
Who Can You Trust?
The markets still don’t seem to be in agreement on this issue.
The market for fed funds futures, which are futures contracts based on interest rates, is pricing in a 62% chance of rates being lower by March. By June, that number increases to 99.9%, and by November, the fed funds futures market calculates the probability of at least one rate cut to be 100% – a sure thing.
But the yield on the 10-year Treasury, which is a general proxy for interest rates, tells a different story.
Back in May, despite the fed funds futures indicating a 99% probability of a rate cut by March 2024, the yield on the 10-year Treasury began a huge move from 3.3% to a high of 5%. So the futures market was forecasting a recession, but the bond market was predicting an overheated economy that would lead to more inflation.
Then, after tagging the 5% mark, the 10-year Treasury yield promptly dropped like a New Year’s resolution in February. In just two months, it slid all the way back down to 3.8% – more in line with the fed funds futures market.
Since the end of the year, however, the yield has climbed back above 4%. The rally has been only a few weeks long, but if it continues, it should make investors at least question whether the rate cuts are in fact written in stone.
Anytime sentiment is so extreme – and a 100% probability of a rate cut is certainly extreme – it makes me strongly consider the alternative view.
There is no reason for the Fed to cut rates anytime soon, especially as early as March. And I see very little probability of six rate cuts by the end of the year.
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