Interest Rate Update - Fed Lowers Rate

The Fed delivered on market expectations with a second consecutive 25 bp cut to the Fed Funds rate.  The big surprise at the meeting was two voting member dissents in both directions.  Recent addition Steven Miran dissented in favor of a 50 bp cut while Kansas City Fed President Jeff Schimd voted in favor of a hold at this meeting.  This highlights the growing disagreement among Fed members on the forward path for rate policy.  Fed Chair Powell pushed back on market expectations for another 25 bp cut at the December meeting stating “a further reduction in the policy rate at the December meeting is not a foregone conclusion – far from it”.  Futures markets took note and pushed expectations for a December cut from 100% down to 75% as of this morning.  

One of the major road blocks for another cut at the December FOMC meeting is a lack of US economic data over the past few weeks and into next month, due to the government shutdown.  Fed Chair Powell attempted to address this issue stating that “despite the lack of government data, available public data suggest not much has changed since September”.  The Fed may decide to move to hold in December given the relative lack of economic data.  There is also the fact that many speculative assets (stocks, gold, bitcoin, etc) continue to trade at or near all-time highs, which is not generally something that occurs during a significant Fed easing phase.  Some may choose to view the current rate around 4% as neutral or closer to neutral as a reason to hold in December.  Fed Chair Powell’s view of labor and inflation was that “risks are to the upside for inflation and to the downside for employment”.  Anecdotally, we’ve seen some corporations announcing job cuts recently and Chipotle mentioned inflation accelerating into the “mid-single digits” on their recent earnings call.  

Rates have been trading in a very tight trading range since the beginning of August.  Over that time, generic 5y swap rates have traded in a 30 bp band with the bottom occurring 10 days before the Fed’s September cut.  The 5 year swap rate was up 10 bps following Fed chair Powell’s press conference and currently trading pretty close to the mid of the recent range.  Term rates don’t have much room to the downside unless there is a large exogenous shock that accelerates job cuts or pushes down inflation.  With markets still discounting an additional 100 bps worth of easing over the next 14 months, we believe there is still great value across the fixed rate curve for floating rate borrowers.

Read PNC Derivatives Market Update - October FOMC Meeting HERE