Central Bank Interest Rates

The US yield curve is sending a crucial signal here. The chart shows how all post gold standard recessions (shaded in orange) have been anticipated by the following pattern: yield curve inversion (2s10s in blue), time lag, steepening, recession. This is exactly the pattern we have followed since June 2022 – but why does it work this way? Yield curve inversions signal monetary policy is too tight: companies and households face harsher credit conditions and hence cut their borrowing activities – with a (variable) time lag the economy slows down. At this point the yield curve steepens. That’s either because the economy or markets broke: the Fed must cut rates fast = bull steepening (2008). Or because it’s taking too long and a ‘’this time is different’’ narrative forces higher term premium and even harsher credit conditions late cycle until eventually breaking something = bear steepening (1980s, today). The inversion has now lasted for 16 months and as the dangerous late-cycle steepening is unfolding under our very eyes it could be beneficial to have a check with Dr. Yield Curve. The passage of time is a boring but crucial variable in this relationship: the longer the yield curve remains inverted the longer markets are signaling tight credit conditions for the private sector. That matters because a longer yield curve inversions means the tightening is getting transferred to a larger and larger proportion of corporates and households. The most recent example concerns the 2008-2009 GFC: the Fed hiked rates rapidly and went for a loooong pause in 2006 by keeping rates ‘’higher for longer’’ for several quarters. The yield curve inversion which started in early 2006 lasted for a long time hence spreading the tightening deeper into the US economy until it finally cracked the housing market and a severe recession unfolded. We are now at month number 16 of persistent yield curve inversion which is being followed by a playbook steepening. And it's the post-inversion steepening you should worry the most about. Interested in trying my institutional research? Send me an IB chat on BBG!

10yr TIPS at 1.8% (chart) is often compared to a guesstimate of #neutral rate to gauge restrictiveness. But the neutral rate, r*, may be higher in the new regime, and this old chestnut will probably be dusted out at #JacksonHole this week, titled "Reassessing the effectiveness and transmission of monetary policy". 3 drivers I monitor: 1/ expansionary fiscal spending and more transition related spending could push up REAL neutral rate. 2/ structural constraints such as labour shortage could push up long run INFLATION. 3/ offsetting upward pressures, trend GROWTH is likely a bit weaker than pre-pandemic.

Dueling Mandates The Federal Reserve’s dual mandate - to foster price stability and full employment - is rapidly morphing into a dueling mandate. The Fed’s Beige Book revealed that the labor market remains stuck in its low hire, low fire, stagnate mode, while inflation is accelerating. It noted stickiness in service sector inflation and incidents of opportunistic pricing. The latter are price hikes on goods that are not directly tariffed but benefit from the lack of completion that tariffs trigger. Shifts in the data prior to the shutdown further complicated the Fed’s assessment of the economy. Employment was revised down, while economic growth was revised up. That is unusual - understatement. Preliminary reports on the third quarter reveal an acceleration of consumer spending. What we have to ask ourselves is why? Is it due to inequality, doing more with less or a measurement problem? Probably some combination of all of the above. The measurement issue is the most important to the Fed. The official data often is slow to capture rapid shifts in the economy. Staffing shortages are worsening that problem. More than a third of the prices in the August CPI were imputed, as field officers were idled earlier this year. How does that distort our view of the economy? If we are undercounting inflation, then we are overstating economic growth. Chair Powell used the words “may be” when talking about the recent strengths of the economy. Revisions could reveal a weaker economy - that is what doves on the Fed are betting. If they are not, we could have more support for inflation than is understood. Adding to the uncertainty we face is the government shutdown, which leaves us with a dearth of data and could be more consequential to the economy than past shutdowns. It is hitting more workers that past shutdowns with threats of larger cuts & ripple effects to the communities in which they live. The bulk of those workers live outside of the beltway in DC. Another challenge for the Fed is inflation expectations. Research by the Boston Fed suggest that expectations may be becoming unmoored, or normalized. Tariffs typically represent a one-time bump in prices, which is self-correcting. The sequencing of tariffs on the heals of the pandemic inflation has left them mimicking inflation. That could further normalize inflation and make it a self-fulling prophecy. Bottom Line The Fed is left with “no risk-free path” for policy. If it doesn’t cut, it risks a recession. If it cuts too aggressively, it could stoke a more persistent bout of stagflation. That has left it moving with caution instead of certitude, cutting in 1/4 point moves to avert the worst in labor market weakness without stoking inflation. Prospects for 2026 are murkier & could shift with changes in Fed leadership. History is unkind to central banks which prioritize employment over inflation. Any gains in employment tend to be short-lived & stoke a more entrenched bout of inflation.

The Federal Reserve is facing a problem that goes deeper than interest rates or inflation prints. I've written my thoughts about it this morning in this article. These are my thoughts. The Fed's own mandate is pulling it in two directions at once and the strain is starting to show. There is a split inside the committee, which became very evident yesterday. Policymakers who share the same data are reaching very different conclusions about where rates should go next. The problem is that the Fed is expected to deliver both stable prices and something it calls maximum employment. The first has a clear target. The second does not. It is a judgement that shifts with demographics, technology and global supply patterns. When inflation remains above target but labour market indicators soften, the mandate offers no obvious hierarchy. Some officials believe employment risks must take priority. Others insist inflation should dominate. This tension matters because it shapes how markets interpret every signal the Fed gives. A divided committee rarely tells a clear story and clarity is the currency central banks trade in. As the world economy changes at speed, does the dual mandate still help the Fed or is it becoming an obstacle to the very stability it is meant to support? The other the question to ask is whether this dual mandate actually threatens the Fed's independence i.e. whatever decision it makes is questioned politically, making it vulnerable to political attack. What are your thoughts?

I've read many comments complaining that the FOMC didn't cut interest rates in June. One thing that I don't believe is appreciated is that a 25 basis point cut in rates is unlikely to spur much activity due to the concomitant existence of such profound economic policy uncertainty, due primarily to tariff policy. As evidence, I wanted to share an excerpt from Bloom (2014) concerning this issue (https://lnkd.in/gew8rQar). Thoughts: •As I've highlighted, economic uncertainty dampens the response that firms have to interest rate cuts. In layman's terms, what this means is that a 25-basis point cut in interest rates generates less capital investment when economic uncertainty is high versus when economic uncertainty is low. •Consider, for example, the situation facing a manufacturer that is considering expanding production. To do so, it must order machinery imported from the European Union. Let's imagine the lead time is 6 months. The fact said manufacturer cannot forecast what tariffs on EU machinery will be in 6 months means that cutting interest rates is less likely to spur that capital investment to occur. Implication: economic uncertainty regarding tariffs compounds negative effects of the tariffs by freezing firms in place. If economic uncertainty continues to remain as elevated as it currently is, eventual FOMC interest rate cuts will be less effective in spurring economic activity. Something to keep in mind as the FOMC still projects two cuts in 2025. #economics #markets #supplychain #supplychainmanagement #manufacturing

In the end, the Fed rate decision was hardly a surprise. Of course, it could’ve been a different story! At the start of the year, many analysts expected March would be the first rate cut. But the inflation and growth data have been hotter than expected since then. And that ended any hopes of early policy easing. Instead, it’s a ‘no change’ from Mr Powell and team. Three points are worth noting for investors : 1️⃣ First, how far are we from the first cut? At the Congressional testimony a few weeks ago, Chair Powell said “not far”. But he didn’t use that phrase today. Globally, central bankers are now more concerned that the ‘last mile’ of disinflation could be hard-going. So the Fed wants to stay data-dependent and retain maximum flexibility. That means that markets will remain ‘hyper-sensitive’ to inflation news. On the balance of the data, we still expect the first cut in June. And Mr Powell also told us that the pace of QT will slow “fairly soon”. 2️⃣ Second, the Fed shared the updated quarterly forecasts – ‘the dots’. In December, they had 3 cuts pencilled in for 2024 and they’ve retained that guidance. But many investors I speak to already assume 2-3 cuts. Something to ponder there. Just as important is the scenario for 2025. Back in September, the Fed assumed 4 further cuts. But they now guide for 3 rate cuts next year. Of course, there’s a wide range around that. But, if delivered, it would mean that the Fed funds rate only goes back to c 4% by the end of 2025 – by historic yardsticks, it would be a very gradual rate cutting cycle. Meanwhile, the Fed upgraded its growth forecasts (now expecting 2.1% GDP growth in 2024), and lowered the unemployment estimate. In other words, the projected scenario is the softest of soft landings. 3️⃣ Third, the long run. A key issue for investors is where interest rates ultimately settle. The Fed has nudged its assumption higher from 2.5% to 2.6%. But this estimate still looks too low - a legacy assumption from the economy of the 2010s. Today’s macro paradigm is different. A number of Fed officials have already talked about 3% or higher terminal rates. And I would expect the long-run assumption to continue to drift higher. No big surprises, but a few interesting tidbits, and a positive tone for investment markets to respond to. The big week for central bankers continues … #fed #economy #markets #investmentstrategy chart source = HSBC AM, Macrobond

The markets are virtually certain that the Federal Reserve will cut short-term interest rates by at least 0.25% (25 bps) today. Here are the main things to think about: - The Fed is in a quandary, since inflation has been running at an annualized rate of about 3.5% over the past three months, which is close to double its 2% target. Cutting rates could make this worse. - But the Fed also has to consider the labor market, which has been stagnating. Job growth has been paltry, and so has the growth of the workforce. Though the official unemployment rate is still low, the growing number of discouraged workers and long-term unemployed is worrisome. - Jerome Powell's statement and news conference today will be important. Cutting short-term rates by 0.25% (25 bps) won't make too much difference to the economy unless the Fed signals that they are planning more cuts. - We still don't know how long-term rates will respond. These are the ones that affect mortgage, car loan, and credit card rates for consumers, as well as investment plans for companies. Credit markets are still under strain at the long end of the curve, and the Fed is offloading its long-term securities. - Regardless of the cut(s) today and in the next meeting, the Fed may not cut as deeply as the market expects. Powell has hinted that the neutral rate – where credit is neither particularly tight nor loose – may be higher than the market thinks. The neutral rate is probably the Fed's target in the medium term. - The current administration wants to see short-term interest rates come down by more than 3% (300 bps) to 1% or below. This policy would be consistent with a deep recession and is unlikely to happen anytime soon. But it would also likely weaken the dollar, another apparent goal of the administration. [Photo: White House via Creative Commons]

Initial jobless claims dropped this week to 217K, below last week's 221K, and the lowest since May. North Carolina and Florida have passed through the hurricane impacts and are back to normal. And, per Bloomberg, mentions of "job cuts" on S&P earnings calls are not increasing (see graph). What does this mean? What it means to me is that maybe the Fed should pause on cutting rates. The economy, by traditional measures (GDP, CPI, Unemployment), is performing very well - almost too well. If they keep cutting rates it could further spike the punch, send GDP to 5%+, and re-ignite inflation. There is potential for a repeat of a late-1970's scenario. Inflation is a legitimate risk. Simply factoring in the potential impact of increasing tariffs in 2025 could do that. So it may be a moment to pause. But we all know that things are not that simple if you're Chairman Powell right now. He has a president-elect wondering if he can "fire" him for not lowering rates fast enough. He has a banking industry teetering under massive Unrealized Losses on their bond portfolios and increasing delinquencies in their CRE portfolios. It's complicated. In addition, Powell is trying to continue shrinking the Fed's balance sheet from too many years of QE pushing Fed assets up over $9 trillion. Through QT they have steadily reduced their assets to just below $7 trillion, as of November 6. All signals are that this is likely to continue for some time. QT is definitely restrictive. And we have that darn housing market which has been so sticky at the crazy-high valuations. So far, despite 2 years of high mortgage rates, a correction in home prices has not been in the cards, making home ownership unaffordable for too many Americans. Setting Fed Funds drives the headlines. But in this Fed Observer's opinion, QT has a larger impact on things, albeit behind the scenes. Banks have to manage that reduction in market liquidity. So far it has been going well, but there may come a point where QT may need to become QE again if they aren't careful. Hence the need for policy balance. And, possibly, in Powell's thinking, the justification for more Fed Funds rate cuts. #fedpolicy #riskmanagement #interestrates

Why Switzerland Cuts While the Fed Waits - Switzerland is the first country to return to ZIRP. With its GDP and inflation both at 1%, Swiss National Bank lowered its lending rate to 0%. Swiss banks that hold excess reserves at SNB, must pay the central bank 25bps, creating a negative rate for the banks. - The ECB has lowered its lending rate to 2% (from peak, ECB cut rates 8x and 250 bp) as inflation has fallen just below its 2% target, while GDP oscillates around 1%. European equities markets came into 2025 undervalued and have rallied hard in ’25 as capital flows, defense spending, and CB easing rates have provided a powerful lift. - On this side of the Atlantic, the Fed has stubbornly kept its rate at 4.25- 4.5% despite inflation and growth slowing to ~2%, The Fed's reluctance to cut rates centers heavily on Powell’s decision to take a "wait-and-see” approach despite the softening in inflation and growth. As Powell waits to see if there is an inflationary impulse driven by Trump’s tariff policies or a weakening job market, neither of which will be actionable in the next few months given the delay in tariffs and the strength in employment. - I am sticking with my call that the Fed will cut rates 2x in 2025, however not likely prior to September. Easing inflationary expectations is my base case. When do you think the Fed cuts, and by how much in 2025? - Powell’s term expires in May 2026, and there is a good chance a new Fed Chairperson will be named this year, prior to the expiration of Powell’s term in May 2026. The front runners are Kevin Warsh, Christopher Waller, Michelle Bowman, and Scott Bessent. Who do you think will be nominated? The President will want to elect a dove since he wants significantly lower rates, providing debt relief given the huge interest expense incurred because of massive deficits. Michelle Bowman wants the nod, as the Fed’s Vice Chair for Supervision said “we should recognize that inflation appears to be on a sustained path toward 2 percent and that there will likely be only minimal impacts on overall core PCE inflation from changes to trade policy,” taking a dovish stance by supporting a rate cut at the next meeting in July. While Powell is being vigilant (or stubborn), dovish talk is in the offing. Notable rally in UST rates this week as 10-year treasuries fell 10+ bps (lower oil prices helped). Governments always want relatively lower rates; eventually the central bank accommodates since they are appointed by the government.

Fed Holds Rates Steady, Signals Two Cuts This Year—But Uncertainty Looms The Federal Reserve kept interest rates unchanged, with its closely watched dot plot now implying a median of two rate cuts by year-end. At first glance, that may sound dovish. But a closer look at the details suggests a more cautious tone beneath the surface. Compared to March, more Fed officials are now penciling in fewer rate cuts, indicating growing divergence within the committee. Meanwhile, the Summary of Economic Projections reveals upward revisions to both inflation and unemployment forecasts—largely due to the impact of tariffs. That shift points to a more hawkish tilt, not a more accommodative one. Adding to the uncertainty, the recent spike in oil prices—driven by geopolitical tensions—is clouding the inflation outlook and complicating the Fed’s policy path. While the Fed’s projections offer insight into its current thinking, their usefulness has diminished in a trade environment shaped by tariffs at levels not seen in decades. Combined with a still-evolving post-pandemic economy, these dynamics make a near-term pivot unlikely until there is more clarity on both trade policy and inflation trends.