End of cutting cycle?
The bond market is not the only one questioning the stance of monetary policy. Federal Reserve officials are also seeing some light.
After cutting interest rates completely since September, at least some Fed officials seem to be thinking: Questions whether further mitigation is justified. Judging by recent statements and the latest minutes of the Federal Open Market Committee (FOMC) meeting in December, the answer appears to be trending toward a resounding “no.”
Minutes of the December meeting released Wednesday showed that at least some Fed officials Concerns about inflation risk grow. “Almost all” officials said the upside risks to inflation were rising and acknowledged that the Fed may have cut rates too much while the economy was still experiencing substantial growth. But despite this new sense of caution, the minutes of the meeting show there is no appetite for a change in direction towards raising interest rates. Instead, the message was one of watchfulness and perhaps quiet regret.
December's interest rate cut was the third in a row, lowering the Fed's target range to 4.25% to 4.5%. Cleveland Fed President Beth Hammack He disagreed, saying he wanted to see inflation move closer to the Fed's 2% target before supporting further rate cuts. Other officials were more diplomatic, hinting that further easing could still be on the table, but that the conditions for further easing, such as a clear economic slowdown or lower inflation, were noticeably absent. Ta.
input Kansas City Fed President Jeff Schmidtwill become a voting member of the FOMC this month. In his speech Thursday, Schmidt suggested that “interest rates may now be very close to their long-term levels,” favoring a gradual, data-driven approach. That doesn't mean further cuts won't be made in the coming months. This means, in Schmidt's view, that there should be no further cuts at all unless the economy weakens enough to require monetary stimulus. It's neutral now.
This is a sharp contrast to the view of Fed Chairman Jerome Powell and Governor Chris Waller, who say interest rates are currently restrictive and will take longer to reach neutral levels.
Market reaction: yields are rising
Here's what's troubling for the Fed: Bond markets don't seem to be buying the official narrative that interest rates are constrained and will continue to fall.. Lower interest rates typically lead to lower yields on long-term bonds. Instead, yields have spiked since the Fed cut interest rates by 50 basis points (bp) in mid-September. The yield on the 10-year US Treasury note was 3.60% before the rate cut, but has since risen to 4.70%.
why? Jim Bianco say it properly, The market may not like rate cuts if they appear to be free. With GDP growth hovering around 2.5%, hardly in recession territory, and with fiscal stimulus looming from the incoming Trump administration, interest rate cuts will do more to dampen inflation expectations than alleviate economic stress. There is a risk of stirring up. The Fed's aggressive efforts may have backfired, raising concerns that monetary policy will become too accommodative when the economy is still operating close to its potential.
Bianco's explanation makes more sense than several alternative theories that are good enough to warrant his attention. Former Chicago Fed President Charlie Evans, for example, pointed to deficits, tariffs, and even artificial intelligence as causes for rising yields, but his answer is more like a collection of economic buzzwords than a coherent theory. . paul krugman Adding his own twist, he suggested that yields may reflect a “crazy premium” tied to concerns about President Trump's policy proposals. However, as Bianco rightly points out, many of these factors were present even before September, when yields fell significantly. The biggest change is that the Fed has suddenly become more eager to cut interest rates.
How long to hold the line
If the Fed's goal was to calm the markets or provide reassurance that the Fed had its eye on the economic ball; The rising yield curve suggests we are missing the point.. Mr. Schmidt's comments, along with those of Governor Michelle Bowman, signal a shift in policy that the easing cycle is likely over. In his Thursday speech, Bowman expressed concern that current policies “may not be as restrictive as others see them,” echoing Powell-Waller's views, although not as much as Schmidt's. He said there was a clear disconnect.
With Schmidt joining the electorate and Bowman's voice carrying more weight as a permanent voter, January's FOMC meeting could provide a clearer signal. No further rate cuts unless inflation cools or growth slows significantly.. This is not necessarily hawkish, but it is very different from the dovish tone that dominated Fed communications in late 2024. In other words, the Fed may finally be ready to take a pause.
A clearer commitment to keeping interest rates stable would help Reduce uncertainty in bond markets. The current ambiguity (the Fed remains nominally open to further rate cuts despite rising inflation concerns) has done little to anchor expectations. The pause may not excite everyone, but it would at least be a sign that the Fed is once again not behind the economic curve.
