Fed Chair Jerome Powell tried to push back on near-term rate cut expectations this week, but markets shoved right back.

 

Pricing this week suggests markets remain concerned that if the Fed waits too long to start cutting rates policymakers will only have to cut more aggressively later on.

 

Though heightened market volatility around it may have been amplified by other events this week, the Fed’s relative reluctance to formally open the rate cut window sparked some interesting market reactions.

 

While most would probably argue that the Fed was a bit late to the rate hike party in 2022, the underlying risk for markets—and the economy—is that it could also be late to the rate cut party.

 

Powell this week acknowledged the risks of cutting too late, especially as inflationary pressures have receded more rapidly than policymakers had expected late last year.

 

But the market reaction this week suggests that risk remains—if not even more elevated.

 

Powell’s comments were successful in culling market pricing of a March rate cut with probabilities fading to roughly 30 % from a peak closer to 90 % in January. Markets simply took that and ran with the idea that a later start to rate cuts might only mean that a greater number of cuts are ultimately needed.

 

Prior to Powell’s comments, markets were pricing in about five 25 basis point rate cuts to around 4.1 % by the end of the year. Now markets are pricing deeper cuts to around 3.8 %.

 

This dynamic is pressuring Treasury yields lower.

 

The benchmark 10-year Treasury note yield has faded to just 3.8 % (in line with rate cut expectations) from a 2024 peak of 4.2 % achieved one week ago, and notably down from the 2023 high of 5%. A break below 3.8 % would mark the lowest level since this past July.

 

New York Community Bancorp’s (NYCB) stock price fell by half following its Q1 earnings report where the dividend was cut by 70%. A drop of that magnitude sparked broader selling pressures within the regional banking sector, raising investor concerns that the ghosts of banking stress that visited markets last spring could be coming back to haunt again.

 

However, our early read is that this is a localized event and not a harbinger of another round of broader regional banking stress on par with what markets weathered last year.

 

RBC Capital Markets analysts noted: “Results had several negative surprises, including a higher-than-expected provision and reserve build, a meaningfully lower margin and outlook, and a dividend cut announcement. We believe that many of these trends are related to the company crossing the $100 billion asset mark and becoming a Category IV financial institution, which is driving increased liquidity and compliance needs, though in aggregate the results were less than expected. The 2024 outlook also suggests some further margin and expense pressures due to these themes.”

 

Inflation is still the name of the game.

 

This is perhaps also where the greatest disconnect between Powell’s comments and current market sentiment lies. The clear takeaway is that the Fed still wants even more evidence, and greater confidence, that inflation is on a firm path back to 2 %.

 

In reality – it likely is.

 

Core Personal Consumption Expenditures Inflation (excluding food & energy) has been running below the Fed’s 2 % target over the past three and six months, at 1.5 % and 1.9 % annualized, respectively.

 

Powell somewhat dismissed those numbers and fell back to highlighting the year-over-year pace at a still-elevated 2.9 %. The Fed is likely closer to the point of declaring victory than policymakers are letting on. It is probable that the Fed won’t wait until annual inflation is back to 2 %, as by then it would be far too late.

 

Markets perhaps just wanted more acknowledgment of recent inflation progress.

 

Other data released this week showed another sharp drop in consumer inflation expectations, (adjacent chart). One-year inflation views have almost unwound all of the rise over the past two years, and are now in line with historically standard levels.

 

The Fed’s goal of approaching the “highly consequential” decision to begin cutting rates “methodically and carefully,” as various policymakers have recently suggested, may seem prudent on the surface, and the market clearly wants a more deft and flexible approach if the Fed is going to pull off a soft landing for the economy.

 

We think the Fed will get there, even if it has stumbled out of the gate. There is 50 % chance a March rate cut will occur based on the incoming data, but, at a minimum, the meeting will likely set the stage for a May cut, with more to follow this year.

 

As always, please let me know if you have any questions or comments.