US interest rates cratered last week as the long anticipated slowdown in jobs growth finally arrived. Over a five day period ending Friday, the yield on the 2 Year treasury note fell from a high of 4.40% to a low of 3.89%. At the long end, the yield on the 10 Year fell from 4.20% to 3.80%. The dramatic move in rates was in part a response to Fed foot-dragging on rate cuts—signaled at the FOMC meeting on Wednesday—but Friday’s jobs report put real energy into the downside acceleration. The report, and the prior revisions lower, quickly shifted market sentiment, which gave way to the rising risk of a recession. In the Fed Funds futures market, anticipated rate cuts in the second half of the year have now nearly doubled from a total of 25-50 basis points (beeps) to 75-100 basis points. Was this all just an overreaction?
Probably not. Many observers, even critics who badgered the Fed for waiting too long to raise interest rates back in 2022, have been arguing for months now that Fed Funds currently at 5.25%-5.50% is unnecessarily high, by at least 100 if not 150 beeps. Indeed, by many measures inflation has now fully fallen to the various preferred measures of the Fed’s 2 percent target. So, the growing opinion that the Fed was making yet another mistake was already in the air before Friday’s jobs report. When the headline number arrived, growth of just 114,000 jobs, the data confirmed those suspicions, and worse, suddenly made Jay Powell and the Fed look as though they were, once again, not in touch with reality.
Now, one can argue that this is just one report and that the general valence of strength in the US economy has not been undermined. That’s reasonable. The counter argument however is that the yield on the 2 Year fell to levels last seen during 2023’s regional banking crisis. And at those levels, a yield around 3.9%, the market is not just suggesting but screaming that Fed Funds are way too high, by at least 100 basis points.
With pressure now bearing down on Powell and the Fed, we can anticipate that whatever arguments the hawks were still clinging to within the FOMC have now collapsed. That opens up two possibilities for the next six weeks into the next meeting: one, that Powell and the doves get loud, and start guiding the market to more aggressive cuts, or two, that the Fed actually does an inter-meeting cut. Those are conditions that are likely to keep market rates suppressed. In other words, unlike 2023’s brief banking crisis, this is shaping up to be a more durable and lasting change in the macroeconomic weather.
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