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U.S. Treasury yields soared after Federal Reserve Chairman Jerome Powell spoke about his outlook on “60 Minutes” as markets priced in one less interest rate cut this year. Powell taped an interview Thursday before Friday’s big jobs report, a fact that only reinforced his message that the Fed is in no hurry to start cutting rates.
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Why doesn’t the Fed cut rates now?
A key part of Fed Chairman Jerome Powell’s “60 Minutes” interview was his response to Scott Pelley’s question: “Why aren’t you cutting rates now, given the rise in inflation?”
“Well, our economy is doing well. We’re growing at a solid pace. The labor market is strong, with an unemployment rate of 3.7%. And inflation is coming down. , we feel we can address the issue of “cautiousness about when to start lowering interest rates.” ”
Chairman Powell said that “acting too soon” could halt disinflationary progress and “could result in inflation settling at a level well above the 2% target.”
Still, Powell’s comments were anything but hawkish. He said the Fed is “increasingly confident” that inflation is on a sustained path toward 2% and that policymakers are “actively considering” cutting rates. .
Powell also said the Fed could cut rates sooner if there are signs of weakness in the labor market or “really convincing inflation coming down.”
Fed Chairman Jerome Powell talks about the health of the banking sector
Mr. Powell’s “60 Minutes” interview also drew attention to something that was largely invisible last week. The Fed’s policy statement released Wednesday afternoon omitted some content that has become customary since the local banking crisis erupted last spring. The Fed dropped its assertion that the U.S. banking system is healthy and resilient and that tight credit conditions are likely to suppress employment and inflation.
This inaction is certainly not because the Fed no longer believes the banking system is strong. Rather, the Fed no longer views bank vulnerabilities as a primary concern in setting policy rates. In other words, credit concerns are not an obstacle to keeping interest rates high.
In an interview on “60 Minutes,” Powell downplayed the risk of distressed commercial real estate loans to the banking sector as a whole.
Mr. Powell said this is a significant but manageable problem, especially for large banks.
“There are some smaller regional banks that are concentrating their exposure in these difficult areas,” Powell said. “This is something we have known for a long time and we are working with them to ensure they have the resources and plans to weather the expected losses. ”
Some “smaller banks, most likely, will have to close or merge and disappear.”
Fed rate cut odds
The probability of a rate cut in the Fed’s March 20 policy update fell to 15% on Monday, down from about 50% before last Wednesday’s meeting. The market is pricing in a 64% chance of a rate cut by May 1, down from about 90% before the meeting.
The market is currently pricing the year-end policy rate at 4.21%, up from just under 4% a week ago. This suggests the Fed is likely to cut rates by 1.25 percentage points in the 4% to 4.25% range, but the probability of a full 1.5 percentage point cut has fallen to 22%.
Government bond yields and S&P 500
The 10-year Treasury yield rose 12 basis points to 4.15% after Friday’s January jobs report rose 17 basis points. Yields have been falling for much of the last year due to concerns from local banks.
The two-year bond yield rose 8 basis points to 4.45%. This was the highest level since December 12, when November’s inflation data was subdued, prompting a more dovish Fed tilt.
The Institute for Supply Management’s service sector activity index rose more than expected to 53.4 from 50.5, contributing to upward pressure on US Treasury yields. Measurements above the neutral 50 level indicate an increase.
The S&P 500 fell 0.3% in Monday’s stock market action, but it was down from its morning low. This comes after the stock rose 1.1% to a record high on Friday.
Be sure to read IBD’s The Big Picture column after each trading day to stay up to date on general trends in the stock market and what they mean for your trading decisions.
Fed considers neutral interest rate
When discussing the Fed’s rate-setting approach, Powell continues to focus on the Fed’s two mandates: 2% inflation and maximum employment. He said little about a question that may be important to investors: What is the neutral rate at which the Fed can achieve both goals?
But the Fed’s uncertainty about the timing and depth of rate cuts is actually based on policymakers’ uncertainty about where the neutral rate is. The Fed’s most recent set of forecasts, released in December, shows the long-term neutral federal funds rate to be 2.5%, or just 0.5% after adjusting for inflation, based on the median view of Monetary Policy Committee members. Ta. If this is the case, the current nominal interest rate of 5.25% to 5.5% is extremely severe and should restrain growth.
However, the economy appears to have gotten off to a solid start to the year, with interest rates at 4.1% in the second half of 2023, raising questions about whether the neutral rate is significantly higher.
Neutral interest rates are important for stock valuations because risk-free U.S. Treasury yields set the standard for risk-taking. When bond yields are very low, like in 2020 and 2021, we are in a TINA (no alternative to equity) environment.
If the neutral federal funds rate is around 3.5%, the 10-year Treasury yield could be around 4.5%, including term premiums based on risk yields that could rise further over the next decade. This is important because analysts use the 10-year yield as a discount rate to value a company’s future cash flows. The higher the rate, the lower the present value.
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