PNC Commentary for you as Fed keeps rates steady

Wednesday’s FOMC announcement featured the first dual dissent since 1993.  Although Fed Governor Waller’s dissent was well telegraphed, there was some uncertainty as to whether or not Michelle Bowman would dissent as well.  Based on Fed Chair Powell’s post meeting press conference, there was a robust debate during this meeting on what the neutral rate is at this point in the economic cycle.  The dovish camp is concerned about a labor market that, while still healthy, has slowed in the last 6 months.  The hawkish camp has been concerned about tariffs and how they will flow through to inflation readings.  This morning’s weaker than expected Non-Farm Payrolls data, coupled with negative revisions to the prior two months subtracting 258k jobs from initials estimates, has pushed the odds in favor of the dovish camp.  Leading into the NFP print market has been looking at a 40% probably of a cut in September and now pricing an 88% chance of a move.  There is still plenty of time for expectations to move again as we’ll get one more full set of data releases and the Fed’s Jackson Hole Economic Symposium before they meet again on 9/17.  

We continue to be focused on what changes may occur at the Fed in 2026.  I noted a recent article on changes Kevin Warsh might make if he were to get the job.  The two significant changes would be to get rid of forward guidance i.e. the quarterly dot plot and to reorganize the regional Fed districts to focus on a “core competency” that they would develop.  The thinking on the dot plot is that the guidance locks them into a preset path in the near term and not having that burden would allow the committee to be more proactive rather than the reactive moves we’ve seen in recent years.  The removal of forward Fed rate guidance is a risk to floating rate borrowers as it would increase rate volatility going forward.

Term rates had been trading in a tight range over the past month with 5y Treasuries moving in a 20 bp band over the course of July.  This morning’s data has pushed rates through the bottom end of recent trading ranges.  Markets are pricing in a full five 25 bp equivalent rate cuts between now and year end 2026 compared to ~4.5 before NFP.  Medium term expectations appear well anchored around low to mid 3s for the terminal Fed Funds rate in this cutting cycle.  With 5y Treasury rates trading at 3.78% today you would need to see a significant deterioration in economic data to move it significantly lower.