Where They’ve Been and Where They Could Be Going
By Brian Schaff
Last week the Federal Reserve made the unanimous decision to raise their benchmark rate 25 basis points. This marks the 11th increase since March of 2022, a total of 525 basis points of increase in less than a year and a half. As a result, the target rate is the highest it’s been in 22 years. There’s no argument that we’re in the midst of a historic hiking cycle, but there’s a question I keep coming back to.
“Have the Fed’s actions had enough time to take effect?”
Bloomberg’s World Interest Rate Probability (WIRP) is a great tool to get a feel for the market’s sentiment regarding the future direction of Fed Funds. With additional hikes no longer priced in (36% chance across remaining 2023 meetings as of 7/28), it’s time to start thinking about the other side of the coin: rate cuts. During his press conference immediately following the rate decision, Jerome Powell said no cuts will be made this year. The market seems to agree, with WIRP projecting about a 50% chance of the earliest cut coming in March of next year. Then, it gets more interesting. A full 25 basis point cut is projected by the May meeting. By the end of next year, the market expects five 25 basis point cuts.
There’s a reason for this, and it has everything to do with precedent. The Fed has handled rate cuts in the past with speed and aggression. The chart below shows the upper bound of the Federal Funds target rate, and provides some perspective.
With regard to their target rate, and up until this hiking cycle, the Fed has a tendency to take the stairs up and the elevator down. Most of the time, the post-cut rate is even lower than it was before hiking began. A phrase I hear thrown around quite a bit is “higher for longer”. Since the early 2000’s, it’s been more like “lower for longer”, with sustained periods of a constant rate (no hikes/cuts) coming at the bottom of cycles.
So what does this all mean, and is this time different? There are no shortage of opinions out there, but I firmly believe that the data combined with past behavior is our best indicator. Statistical probabilities point to rates sinking lower on a long-term basis and returning to their respective means. Look at what the Fed has done. When the full gravity of this hiking cycle takes root in the economy, the Fed will most likely have to react swiftly, as they always have. Normalization of the yield curve will likely involve short rates plunging along with the target rate, rather than the long end of the curve coming up to meet them.
We heard a lot of ambiguous Fed speak last week with phrases such as “data dependent” and “continued assessment”. However, the message I hear is loud and clear.
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