The spread on interest rates between what the futures market and the Federal Reserve board predict has tightened lately, as investors have grown less optimistic that the Fed will slice them deeply. That results from improved expectations that call for economic growth and no recession.
“The gap between market expectations for rate cuts this year and Fed projections—a source of both equity and fixed-income market volatility—has finally started to narrow,” stated a report by Adam Turnquist, chief technical strategist for LPL Financial.
U.S. gross domestic product expanded at a 3.3% annual rate, as of the December 2023 quarter, up from 2.5% from the year before, defying earlier estimates that GDP would be negative for last year. Personal income and spending reports for December also were up.
The Consumer Price Index, too, has ticked upward, suggesting to many its trend of falling has stalled out. The CPI was 2.9% in January, way down from the high of 9.8% in June 2022, but up from its 2.3% low point in June 2023. This poses frustration for the Fed, which wants 2% inflation.
The futures market’s betting, from the CME Group, now leans toward four quarter-point cuts in 2024, with the benchmark fed funds rate finishing in a range of 4.25% to 4.50% by year-end, with the first cut coming in June. As recently as early January, the market had targeted six cuts, beginning in March, with the fed funds rate a half percentage point lower. Now, according to the CME, it is expected to reach a 3.50% to 3.75% band.
Fed policymakers’ prediction for 2024, from their last meeting in December, implied three cuts and an interest rate in the 4.50% to 4.75% range. That was slightly more than its earlier indication from September. (The rate-setting Federal Open Market Committee’s members list their predictions every three months.) So now, only one anticipated cut separates the market and the Fed.
In addition to the impact on short-term rates, the more sanguine economic news has prompted higher yields on the 10-year Treasury, which has a bigger impact on the stock market. The 10-year now is at 4.25%, up from 3.84% at year-end 2023.
Higher 10-year yields potentially could attract investors away from stocks. Such a development, Turnquist wrote, “would likely act as a headwind for the broader equity market landscape.” The most vulnerable, he noted, would be defensive sectors, in particular utilities, consumer staples and real estate. “At the index level, global markets could also lag if yields continue higher,” he added.
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Tags: 10-Year Treasury, Adam Turnquist, CME Group, CPI, fed funds rate, Federal Reserve, FOMC, Interest Rates, LPL Financial, Stocks