Traders Getting Ahead of Themselves on Fed Funds Rate Cuts

With the global bond rally continuing and equity markets struggling over the past month, bond traders have made a drastic shift in what they expect the Fed to do with the Fed Funds rate. Of course, falling stock prices and rising bond prices aren’t the only culprits in the shift.

Stocks have fallen over the past month after the trade war with China took a turn for the worse. It was on May 5 when President Trump announced new tariffs on Chinese goods and that tweet came just ahead of another round of meetings to negotiate an end to the dispute.

President Trump surprised the market again with a tweet late last week that he would place tariffs on goods from Mexico. The tariffs are a retaliation for what the president sees as a lack of effort on the Mexican government’s part on protecting the border.

Both of these changes in the trade environment rattled global equity markets, and they caused huge rallies in global bond markets. Depending upon which segment of the treasury market you choose to watch, some segments have moved to an inverted yield curve and the difference in the inversion has reached levels not seen since 2007.

Traders in Fed Funds futures have taken these factors into account and they are now pricing in two and possibly three rate cuts between now and January. If we look at the Fed Watch Tool from the Chicago Mercantile Exchange, traders are pricing futures such that a rate cut is expected for the July meeting on July 31.

Looking out to January 2020, a meeting of the FOMC is scheduled for the 29th of the month. The probability calculator shows the greatest probability in the 1.50% to 1.75% range at the end of that meeting.

Fed Chairman Powell has been reluctant to move off of the neutral stance the Fed shifted to toward the beginning of the year while President Trump has been pushing for rate cuts. The Fed wants to keep the appearance of not yielding to political pressure, but with the two tweets regarding trade, President Trump may have pushed the Fed’s hand.

Personally, I can’t see the Fed making such a drastic move as to cut rates three times between now and January. If they do, I would say that it is because of more than the stock market falling by 10%. If the Fed cuts rates three times, I would think it would mean we were seeing much lower GDP numbers in the second and third quarters and that something drastic had changed on the employment front.

I would caution investors and President Trump to be careful of what they wish for. If the Fed takes such drastic actions and makes three rate cuts in the next eight months, I would expect that we were flirting with a recession. For that to happen, the GDP that grew by 3.1% in the first quarter would have to be showing much slower growth and possibly even showing a contraction.

About Rick Pendergraft

Rick has been studying, trading, analyzing and writing about the investment markets for over 30 years. He has worked for some of the largest financial publishers in the world and he has been quoted in the Wall Street Journal, USA Today, the New York Times and the Washington Post. In addition, he has been interviewed on Bloomberg, CNBC and Fox Business News. Rick’s analysis process includes fundamental, sentiment and technical analysis. Rick started college as an education major, wanting to teach economics, but eventually changed to majoring in Economics and received a Bachelor of Science in Economics from Wright State University. His desire to inform and educate people is at the heart of his writing.

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