For the first time in four years, the Fed cut interest rates. Here’s what it means to you — according to KPMG’s Senior Economist Ken Kim.
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What should Treasurers do following the Fed’s rate cut announcement?
For those managing liquidity in the belly of the curve, Treasurers should be thinking about adding duration to capture the higher returns out along the curve as the rate cutting cycle kicked off today. The Fed’s newly released projections imply an additional 50 bps reduction in total for the federal funds rate target in Q4 2024 and another cumulative 100 bps reduction in 2025, which implies more steepening in the curve this year and next.
The Treasury yield curve for 2s10s has dis-inverted further and normalized with long-term yields now above shorter ones. The 2-year note currently yields 3.62% and the 10-year note yields 3.70%, which is more normal behavior. At the start of September, the curve was inverted with the 10-year returning below the 2-year yield.
Were there any surprises in the announcement?
The statement on the Fed’s decision shifted to hedging against the risk of a further weakening in the job market. The statement changed the verbiage on hedging against additional inflation to hedging against a further weakening in the job market, “The Committee is strongly committed to supporting maximum employment and returning inflation to its 2% percent objective,” the statement said. The Fed is clearly worried about the slowdown in the labor market. Payroll employment slowed to 116,000 on a three-month moving average.
What do you think will happen next? Are more cuts coming by the end of the year/early next year?
The Fed today begun its rate cutting cycle with an outsized one-half percent cut. Our forecast for another half percent by year-end holds. Fed Chair Powell stayed away from promising another half percent move prior to year-end during the press conference but that did not stop financial markets from pricing in even more rate cuts than participants at the meeting forecasted. Market participants are pricing in a combined 75 bps in rate cuts by year end even after accounting for today’s large-sized 50 bps reduction.
What should Treasurers look for to help predict the Fed’s next move?
Given that the Fed feels that inflation is making further progress toward the Committee’s 2 percent inflation objective, the focus will be on the labor market and the resiliency of the US consumer. Any further deceleration in the labor market from current levels would not be welcome nor signs that consumer spending is faltering. Powell characterized the US economy as in a good place and their decision today is designed to keep it there. A rising unemployment rate would put the economy’s standing in the good place in jeopardy.
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