Let’s See If The Fed Is ‘Listening’

June 3, 5:00 pm EST

Back on December 19th, the Fed hiked rates into a sharply falling stock market.  This turned out be the last rate hike in its “rate normalization program.”

Here’s an excerpt from my Pro Perspectives note from December 19th, following the Fed meeting:

“This sets up for what looks like an ugly finish for the year. Remember, as we discussed on Monday, we talked about the similarities to 1994. The Fed, back in 1994, was also systematically raising interest rates into a low inflation, recovering economy — in anticipation that inflation would quicken. It didn’t happen. They ended up choking off growth.

This is the first time since 1994 that stocks, bonds, real estate and gold have all been losers on the year (negative returns). And the first time cash has been the highest return asset class. As we discussed,the Fed had to reverse course and cut rates in 1995, which finally unleashed the stock market, which finished up 36% that year.

Bottom line: The Fed has been, by their own admission, walking a tightrope trying to raise rates without killing the recovery. They now clearly have signals, in the plunge in stocks and oil prices, that they may have gone too far.

Fast forward to today, and the markets have clearly signaled that the Fed made a mistake (at least) with the last rate hike.

With that, the rate cut chatter is now loud.   The interest rate market is pricing in a 60% chance of a cut at the July meeting.  And we’re now hearing more and more aggressive projections for where the Fed will take rates by year end.  Barclay’s thinks they will cut three times this year.  That’s anticipating a lot of economic deterioration.

Still, with that extreme viewpoint out there, the market is still underpricing the chance of a rate cut this month — at the Fed’s June meeting on the 19th.  That sets up for a surprise.

And we may get some signals tomorrow, as Jerome Powell is scheduled for a prepared speech at a Chicago Fed conference (9:55 EST).   Interestingly, the conference is called “Fed Listens.”  Let’s see how well they are listening to markets.

It’s not uncommon for the Fed to float some policys shift balloons.  We saw plenty of it in January, when they went on a public campaign to make clear to markets that they were done with interest rates hikes.  They have since moved to a neutral stance.  Today we Jim Bullard — St. Louis Fed President, a voting member — say a cut may be “warranted soon” to “provide some insurance” in case of a sharper slowdown.

The 10-year yield seems to keep bleeding lower, forcing the Fed’s hand.  The 10-year yield is now 43 basis points below the top end of the Fed Funds target range (2.25 to 2.50%).

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