Interest Rate Market Commentary: What The Fed Needs to Move Rates Lower

June 05, 2024

Interest Rate Market Commentary: What The Fed Needs to Move Rates Lower

By Serafino Tobia, Managing Director & Head of Agency CMBS Trading, Greystone

10-year Treasury yields are at 4.35%, moving to the low end of the recent range after a bond-friendly April PCE inflation print on Friday (5/31) followed by a weaker than expected ISM Manufacturing Index print on Monday (6/3). Early last week, yields moved higher with tepid demand for the bonds auctioned by the US Treasury; as of the close on Wednesday (5/29), the 10-year Treasury stood at 4.61%. Bond investors, however, are refocused now on both the marginally better inflation numbers and marginally weaker economic data foreshadowing easier monetary policy from the Fed and a Fed Funds rate cut.

The PCE inflation numbers were incrementally better/lower (and largely in line with Wall Street estimates). The year-over-year headline PCE index printed +2.7%, annual Core PCE (without the more volatile food and energy prices) printed at +2.8%. For the month of April, the headline PCE index printed at +0.3%, as expected and the same as the previous two months. The Core PCE index month-over-month was +0.2% (actually, +0.249% unrounded). Clearly a step in the right direction especially after the higher prints during the first 3 months of the year (monthly Core PCE for January +0.5%, February +0.3% and March +0.3%). However, annualized, Core PCE Index is 3% (0.249% x 12); and that doesn’t get us to Fed rate cuts without further improvement. The May ISM Manufacturing Index composite came in at 48.7, down ½ point from April’s number. Wall Street was expecting a slight uptick to 49.6. A print below 50 represents contraction in the economy.

Since July 2023, the Federal Reserve Bank has maintained a restrictive overnight Fed Funds rate; 5.25%-5.50% range. There are two paths to Fed Funds rate cuts – (1) an improvement in inflation that gives the Fed confidence that we are back on track towards the Fed’s 2% inflation target or (2) a weakening economy that necessitates the Fed to address their full employment objective with an easier money policy. For the Fed to start cutting rates, we probably need inflation prints at +0.2% month-over-month for two months in a row (or an unemployment rate higher; 4.1% or 4.2% unemployment rate, versus 3.9% currently).  

I wouldn’t be waiting for any major improvement in interest rates; we’ve been in a range of between 4.35% - 4.70% for the past 60 days and now at the low end of this range. If you believe (as I do) that the economy is moving towards a soft landing (not a significant recession) and that inflation will stay sticky at around 3% annualized we won’t likely break out much lower.  Also, on a fundamental basis, even if we get further improvement on inflation to around 2.5% and the Fed starts to normalize rates, the 10-year should be around 4.25% +/- (i.e., inflation goes to ~2.50%, implying a ~3.50% overnight Fed Funds rate and an add-on spread for term). Despite my thinking about fundamentals, there may well be momentum that carries 10-year Treasury yields down to 4% or lower. We saw that just six months ago when the market was pricing-in 150+ basis points in Fed Funds rate cuts and the 10-year Treasury traded as low as 3.80% (12/27/2023). The bond market wasn’t totally irrational; we had Core PCE inflation prints of about +0.1% in each of the last three months of 2023, only to be disappointed by a print at +0.5% for January 2024.

This week’s economic data includes a series of employment figures, highlighted with the US Employment Report (non-farm payroll and unemployment rate) on Friday (6/7). The market consensus is for +190,000 new non-farm payroll jobs (versus last month’s job growth at +175,000) and for the unemployment rate to remain at 3.9%, the same as last month. The bond market will also focus on the Average Hourly Earnings print on Friday (6/7), a gauge of wage inflation; the consensus estimate is for an increase of +0.3% month-over-month (vs. last month’s +0.2% print). Additional economic data weighing in includes a JOLTS Job openings report on Tuesday (6/4) and an ADP Jobs report on Wednesday (6/5) and Weekly Initial Jobless Claims on Thursday (6/6).   

The information provided on this website, including, without limitation, any opinions, predictions, forecasts, commentaries or suggestions, is for informational purposes only and should not be construed to be professional or personal investment, financial, legal, tax or other advice.