Federal Reserve’s Next Rate Cut May Trip Up Markets
Investors believe the Federal Reserve is likely to cut interest rates in the near future. However, the timing of such a cut could present challenges for the markets.
According to data from Ned Davis Research dating back to 1970, the yield on the 10-year Treasury note has historically declined in the three months leading up to the first rate cut of a Fed easing cycle. The yield on the 10-year note stood at 3.95% on December 20, three months before the expected quarter-point rate cut in March.
Historical data shows that the yield on the 10-year note has fallen in the three months leading up to the first cut during previous easing cycles, with a mean decline of 0.9 percentage points. If this pattern holds true, the yield could potentially fall to 3.57%. Joe Kalish, chief global macro strategist at Ned Davis Research, noted that a few weak economic reports could push yields down to this level.
In contrast, stock performance has generally been relatively flat in the run-up to an initial rate cut. The S&P 500 has seen minimal gains since December 20, rising just 0.1%.
After the first rate cut, stocks have historically tended to rally over the next six to seven months, with the S&P 500 seeing a mean gain of 12%. However, traders are cautious as the Fed has not ruled out further rate hikes, and speculation about the number and timing of future rate cuts is influencing market sentiment.
According to the CME FedWatch tool, traders have decreased their expectations for a March rate cut, with a 66.4% probability compared to nearly 87% a week ago. However, they have priced in a nearly 60% probability of the Fed cutting rates by at least a quarter-point at least six times over the course of 2024.
The historical data suggests that Treasury yields would rally if a March cut occurs. However, the timing of the rate cut could disrupt this trend. Additionally, concerns about the aggressive pace of rate cuts priced in by the market indicate uncertainty.
Investors are weighing the potential impact of the Fed’s decisions on both equities and Treasuries, as future rate cuts would indicate a tougher economic scenario. The market is closely monitoring the Fed’s next move to determine its impact on various asset classes.