The Fed cuts rates again … only two cuts forecasted for next year … sideways inflation is the issue … stocks tank … keep your eye on the 10-year Treasury yield
Today, the Federal Reserve cut interest rates by 25 basis points in a split vote where one Fed president voted to hold rates steady. The new fed funds target rate is 4.25% - 4.50%.
While this cut was expected, what was unexpected – and roiled the markets – was the new forecast for rate cuts next year.
The consensus among Fed officials is now for only two rate cuts in 2025. That’s down from the September forecast of four cuts.
Behind this reduced forecast is an upward estimation of inflation. Back in September, the median Fed official saw inflation at 2.1% at the end of 2025. Today, that median figure jumped to 2.5%.
In his press conference, Federal Reserve Chairman Jerome Powell said that the Fed is “on track to continue to cut.” But he noted that officials would need to see more progress on inflation before enacting those cuts: As we think about further cuts, we’re going to be looking for progress on inflation… We have been moving sideways on 12-month inflation.
As for the economy, Powell was overwhelmingly optimistic, saying, “I think it’s pretty clear we have avoided a recession," and "we think the economy is in a really good place.”
However, Wall Street wasn’t interested in Powell’s economic optimism. Its takeaway from today was “fewer rate cuts in 2025 means less spiking of the punchbowl for stocks.”
The Dow collapsed 1,100+ points while marking its first 10-day losing streak since 1974… the S&P fell 3%… and the Nasdaq lost 3.6%.
Meanwhile, the 10-year Treasury yield has jumped to 4.51% as I write, which is the first time it’s been above 4.5% since last May.
Wall Street, we have a problem… Where does the 10-year yield go from here, and what will it mean for stocks?
For newer Digest readers, the 10-year Treasury yield is the single most important number for the global economy and investment markets.
Interest rates and asset values worldwide are directly impacted by whether the 10-year Treasury yield rises or falls.
The higher it climbs, the more pressure it puts on most stock prices because a higher yield means a higher discount rate, which lowers the current valuation of a stock.
As I’ll show you in a moment, the 10-year yield has been climbing since the Fed began cutting rates in September. And in the wake of the Fed’s decision, it’s roared higher.
If it doesn’t cool off, this is going to be a big problem for your portfolio.
Since the Fed began this rate-cutting cycle back in September, the 10-year Treasury yield’s behavior has bucked expectations Usually, lower interest rates would result in lower treasury yields. Instead, the 10-year Treasury yield has exploded from about 3.71% to 4.51% since the first rate cut September 18th.
This is quite abnormal.
Below is a chart from Steno Research that we featured in the Digest in late-October. The chart shows how the 10-year Treasury yield has behaved in the wake of past Fed rate cuts compared to how it’s behaving today.
The black line is the median move in the 10-year yield. The shaded gray area covers the 20th through 80th percentiles of moves.
The blue line (circled in red) shows what happened between the September cut and the ensuing several weeks. It had never occurred before.
The situation has only grown more abnormal since.
The 10-year Treasury yield continued climbing from roughly 4.19% when this chart was published to its yield as I write of 4.51%.
By the way, this yield was at just 4.38% this morning before the FOMC decision and Powell’s press conference.
Now, why has it been climbing despite rate cuts? Because the bond market is paying more attention to growth/inflation/spending forecasts than the Fed
The bond market has been reacting so unusually to rate cuts because it doesn’t believe that inflation and government spending will play nice with the Fed’s rate-cutting plan.
For perspective, rewind to September…
Traders were all but certain that by January, the Fed would have lowered its target rate to at-or-below 3.75% - 4.00%. Specifically, that probability was 88.6% - a near lock.
Today, that probability is 0%.
Not only that but the odds that the Fed will lower rates to 4.00% - 4.25% by January are also now 0%.
I have to note that the degree to which futures traders have been wrong about the Fed – for well over a year at this point – has been truly breathtaking.
Now, as I just noted, behind this massive recalibration is growing fear of reinflation and deficit spending (meaning more debt issuance).
Here’s Barron’s from yesterday: Bond investors have been ditching longer-term Treasuries since the Federal Reserve started cutting interest rates in September…
Some economists believe lower borrowing costs, coupled with Trump’s plans to cut taxes and raise levies on imports, will trigger a flare-up in inflation, which could add to the selloff.
The Treasury Department is also expected to auction off more bonds as the deficit carries on rising—and higher supply typically leads to higher yields.
The Barron’s article quotes T. Rowe Price’s CIO of fixed income, Arif Husain, who believes the 10-year yield at 5%+ or even 6% is possible in 2025: The new U.S. administration represents meaningful new information, and at a minimum, it creates uncertainty and a broader set of outcomes. Is a 6% 10-year Treasury yield possible? Why not?
And yet the Fed cut rates again today.
