The Federal Reserve is about to embark on an interest rate cutting campaign. Finally! After 11 interest rate hikes, the Fed Funds rate has remained at the same 5.25% to 5.50% range for far too many months. Keeping the Fed Funds rate higher for an extra 8 months was because inflation data prevented rate cuts early in 2024. Now the jobs market is showing signs of cracks. The Treasury yield curve and other easy-to-assess indicators are signaling that interest rates will be coming down handily over the next year. Not sharply, and certainly not rapidly. But handily. Forget about this first rate cut. It’s time to think about rates a year from now.
The WSJ yield table shows yields on the 1-month and 3-month T-bills are 5.00% and 4.88%, respectively. The yields on the 1-year T-Bill and the 2-year Treasury note are 4.02% and 3.59%, respectively. Thereafter there is a flattening of the curve from 3-year to 7-year Treasury notes. You have to go to a 3.65% 10-year T-Note and 3.98% 30-year T-Bond before interest rates go back up. The spready between 2’s and 10’s is a mere 6 basis points and they are both 150 basis points lower than the current Fed Funds rate.
Oggonomics has been in the camp that Jerome Powell and the voting members of the FOMC have waited too long to cut interest rates. By being so data dependent (on data that is usually 20 to 45 days old on average), they have been behind the curve for about six to eight months. Now Jerome Powell and his voting regional presidents who make the FOMC’s rate decision have to worry about the new odds of a recession. And the markets have done part of their job for them.
REAL INTEREST RATES IN THE ECONOMY
Here is where things get real tricky on interest rates — U.S. businesses and consumers do not live on the Fed Funds rate at all. Most new mortgages are based generally off of the 10-year Treasury (or 30-year if you must insist, but it’s the 10-year really). Most business lending is based around the Prime Rate charged by banks and most credit cards are based on extreme premiums to short-term rates. Here are the interest rates that the U.S. is really dealing with:
- Conventional Mortgages — currently 6.73% for a 30-year and 6.02% for a 15-year (WSJ)
- Jumbo Mortgages — currently 6.78% (WSJ)
- 5-Year Adjustable Mortgages (ARMs) — 6.01% (WSJ)
- Credit Cards — 27.8% (Forbes Advisor’s weekly report)
- Prime (businesses) — 8.50% (Banking Rates)
- New Car Loan (48 months) — currently 7.75% (WSJ)
The reality is that U.S. consumers and businesses that are not large enough to issue hundreds of millions in bonds in the capital markets are paying a massive premium in interest rates compared to what investment rates are. Many of these loans that have been taken out in the last year and many loans that are pending at the present time are likely to refinance over the next year or so if interest rates come down the way they are expected to. There is a huge caveat here — long-terms rates and intermediate rates have already come back down to levels reflecting future cuts.
SOFT LANDING OR HARD LANDING?
According to Goldman Sachs, the U.S. is still most likely headed for a “soft landing” rather than a recession and the firm sees only a 20% chance of a US recession over the next 12 months. That recession probability is currently halfway between the 15% odds of the Goldman Sachs economists estimated just before the weaker-than-expected July jobs report and the 25% odds that the team had estimated right after the weak jobs report.
Goldman Sachs has also noted that most other recent economic indicators have remained sold. These indicators include nonmanufacturing ISM, initial jobless claims, and personal consumption. And the Goldman Sachs U.S. GDP tracking estimate for the third quarter is at 2.5%.
One of the greatest historical tools for projecting a recession or major economic slowdown outside of interest rates is the stock market. The S&P 500 was off to a very weak start of September (Sept/Oct are the worst months historically for stocks). Then the second week of September brought a recovery and the broader-economic index S&P 500 is back to within 1% of its all-time high! The tech-dominated NASDAQ is still about 5.3% from its all-time high as the rotation away from tech mega-caps has favored other mid-cap and large cap sectors.
THE FED’s OWN GDP INDICATORS
The New York Fed staff’s Nowcast factors in weekly changes to economic reports. That forecast, which is not a formal prediction of course, is modeling GDP growth of 2.6% for Q3-2024 and is now modeling 2.2% GDP growth in Q4-2024.
Another Fed outlook tool is the GDPNow tool from the Federal Reserve Bank of Atlanta. As of September 9,2024, the latest estimate for Q3-2024 is 2.5% GDP — up from 2.1% on September 4. The gain is after recent data surrounding jobs, ISM data, wages, consumer/producer prices, and higher real personal consumption expenditures growth.
WHAT TO EXPECT IN RATE CUTS
Goldman Sachs Research’s latest forecast is calling for three Federal Reserve rate cuts of 25 basis points each at the remaining FOMC meetings left in 2024. This emphasizes that rate cuts will be made carefully rather than boldly. The CME FedWatch Tool ended this last week at exactly 50/50 on whether Powell and the FOMC would make a 25 basis point cut or a 50 basis point cut. This means the Fed Funds range will drop down to 4.75%-5.00% or just to 5.00%-5.25%. Here are the current chances beyond this September FOMC meeting:
- The next FOMC meeting is November 7, and the largest percentage is 50% that Fed Funds will be in the 4.50%-4.75% range.
- Then the December 18 FOMC decision is projected to be 4.00%-4.25% (41.3% chance) or 4.25%-4.50% (33.2% chance).
- Jump 4 meetings into 2025, the June rate highest odds are 3.00-3.25% (31.0% chance) – followed by 2.75-3.00% (27.2%) and 3.25-3.50% (19.5% chance).
- Jump to December-2025 and the highest probability is 2.75-3.00% (26.3% chance) – followed by 2.50-2.75% (23.2%) and 3.00-3.25% (19.3% chance).
Regardless of how the economic data come now, the current trajectory is that short-term interest rates are again digging in for short-term interest rates to be 2 full percentage points lower as we get deeper into 2025. The long-term rates and intermediate-term yields have already done a lot of the Federal Reserve’s work for them. Now we just have to hope that the current voting FOMC members do not remain to belligerent to act as the live money bets have already projected.
We all have to keep in mind that The CME FedWatch Tool and any longer-term forecasts will gyrate mildly to wildly based on economic reports, economic shocks, corporate earnings reports, inflation and wage trends and other issues which move financial markets. None of these are set in stone.
