By Serafino Tobia, Managing Director & Head of Agency CMBS Trading, Greystone
10-year Treasuries are at 4.56% as of April 11, higher by 32 basis points from April 1 (4.24%). Investors and traders have recalibrated the likelihood of Fed rate cuts after three months of stubbornly high inflation prints, a blockbuster US Employment Report for March (+303,000 new jobs and an unemployment rate that edged lower by 0.1% to 3.8%), and the chorus of Fed officials that echoed Fed governor Christopher Waller’s previous comment: “What’s the rush?”
The Fed Dot Plot (a survey of the 19 Fed officials Fed Funds rate forecast over the next two years) from March 20 seems stale and dated now. Just three weeks ago, the Dot Plot forecasted the Fed Funds rate lower by 0.75% by year-end but it was delivered with the caveat that we will need to see inflation prints that demonstrate that inflation is back on track towards the Fed’s 2% target. The problem is - the first three months of inflation data aren’t cooperating. Reported Wednesday April 10, the headline Consumer Price Index (CPI) is at 3.5% year-over-year (higher from last month by 0.3% and the highest reading since September 2023). The March Core CPI (consumer prices without the more volatile food and energy prices) increased by +0.4% for a third straight month in March. The first three monthly prints of the core CPI this year reflect an annual inflation pace of +4.50%; the last six months reflect an annual pace of +3.9%.
The inflation prints back in November and December 2023 at +0.2% on a month-to-month basis (2.4% annualized) had us hoping for an orderly trajectory towards 2% inflation along with job growth and a strong economy. Paul Krugman, economist and The New York Times writer, dubbed it “Immaculate Disinflation” (i.e., lower inflation without a recession). The markets and Fed officials were leaning towards their first rate cut, possibly as early as March 20, 2024. However, the sticky rebound in inflation during the first three months of 2024 has put the Fed “on hold” at best. I expect the Fed to stay on hold until we see some data that shows inflation improving once again.
The overnight Fed Funds target range now remains at 5.25% to 5.50%. The bond market is leaning more hawkish than the Fed’s Dot Plot; the CME-traded Fed Funds futures imply less than 0.50% in rate cuts this year and pushing back the likely first 0.25% rate cut to September or later (vs. the previously implied March and then June rate cut). In short, economic data isn’t supporting a dovish shift in Fed monetary policy – inflation has been sticky and employment and production has been strong.
A 10-year Treasury rate in a range of 4.50% +/- 0.25% seems about right, fundamentally (expected inflation at around 3% plus spread for a real Fed Funds rate and an add-on for term). Clearly, we need to start to see monthly core CPI and core PCE inflation prints at +0.2% or lower for the case to be made for easier money from the Fed and a 10-year rate back towards 4% or lower.