Let’s investigate Fed Fund Futures and rate cut expectations.
The above chart is adapted from May and June CME Fedwatch Futures.
The next Fed meeting is on May 7. As of March 23, the market thinks there is only a 22.1 percent chance of a single quarter-point cut.
But if we further out to the following FOMC meeting on June 18, rate cut odds jump to a combined 77.9 percent for at least one quarter-point cut.
September CME Fedwatch
September CME Fedwatch Synopsis
- No Cut: 4.1 Percent
- One Cut: 24.0 Percent
- Two Cuts: 43.2 Percent
- Three Cuts: 25.5 Percent
- Four Cuts: 3.2 Percent
- At Least Two Cuts: 71.9 Percent
- Three or Four Cuts: 28.7 Percent
Weighted Average Expectation
The weighted average expectation is 3.876 percent. That’s smack in the middle of the two rate cut range of 3.75 to 4.00 percent.
Fed Holds Key Interest Rate Steady
On march 19, I reported The Fed Ups its Inflation Forecast, Holds Key Interest Rate Steady
Summary of Economic Projections: GDP lower, Inflation higher, Unemployment rate higher.
Dot Plot
The weighted average of the Summary of Economic Projections (SEP) Dot Plot is 4.007.
That’s 0.131 percentage points higher (about an eight of a point ) than CME Fedwatch, roughly 1.5 cuts instead of two.
And it’s through December, not September. Through December, the market expects one more quarter-point cut than the Fed.
Is Market Driving Rate Cuts?
No, not really. The Fed jawbones the market with nonsense about inflation expectations, dot plots, and forward guidance.
The market tends to front-run Fed jawboning.
But when the market gets too far in front or behind what the Fed wants to do, a parade of Fed governors starts yapping, generally in-line with what the Fed Chair wants to do.
The Fed Uncertainty Principle
Please consider The Fed Uncertainty Principle written April 3, 2008 before the collapse of Lehman Brothers and Bear Stearns.
Does the Fed Follows the Market?
Most think the Fed follows market expectations.
However, this creates what would appear at first glance to be a major paradox: If the Fed is simply following market expectations, can the Fed be to blame for the consequences? More pointedly, why isn’t the market to blame if the Fed is simply following market expectations?
This is a very interesting theoretical question. While it’s true the Fed typically only does what is expected, those expectations become distorted over time by observations of Fed actions.
If market participants expect the Fed to cut rates when economic stress occurs, they will take positions based on those expectations. These expectation cycles can be self-reinforcing.
The Observer Affects The Observed
The Fed, in conjunction with all the players watching the Fed, distorts the economic picture. I liken this to Heisenberg’s Uncertainty Principle where observation of a subatomic particle changes the ability to measure it accurately.
The Fed, by its very existence, alters the economic horizon. Compounding the problem are all the eyes on the Fed attempting to game the system.
A good example of this is the 1% Fed Funds Rate in 2003-2004. It is highly doubtful the market on its own accord would have reduced interest rates to 1% or held them there for long if it did.
What happened in 2002-2004 was an observer/participant feedback loop that continued even after the recession had ended. The Fed held rates rates too low too long. This spawned the biggest housing bubble in history. The Greenspan Fed compounded the problem by endorsing derivatives and ARMs at the worst possible moment.
In a free market it would be highly unlikely to get a yield curve that is as steep as the one in 2003 or as steep as it was just weeks ago when short term treasuries traded down to .21%.
The Fed has so distorted the economic picture by its very existence that it is fatally flawed logic to suggest the Fed is simply following the market therefore the market is to blame. There would not be a Fed in a free market, and by implication there would be no observer/participant feedback loop.
In my post, I provided four key corollaries with discussion. Here is a short synopsis condensed from the full post.
Fed Uncertainty Principle: The fed, by its very existence, has completely distorted the market via self-reinforcing observer/participant feedback loops. Thus, it is fatally flawed logic to suggest the Fed is simply following the market, therefore the market is to blame for the Fed’s actions. There would not be a Fed in a free market, and by implication, there would not be observer/participant feedback loops either.
Corollary Number One: The Fed has no idea where interest rates should be. Only a free market does. The Fed will be disingenuous about what it knows (nothing of use) and doesn’t know (much more than it wants to admit), particularly in times of economic stress.
Corollary Number Two: The government/quasi-government body most responsible for creating this mess (the Fed), will attempt a big power grab, purportedly to fix whatever problems it creates. The bigger the mess it creates, the more power it will attempt to grab. Over time this leads to dangerously concentrated power into the hands of those who have already proven they do not know what they are doing.
Corollary Number Three: Don’t expect the Fed to learn from past mistakes. Instead, expect the Fed to repeat them with bigger and bigger doses of exactly what created the initial problem.
Corollary Number Four: The Fed simply does not care whether its actions are illegal or not. The Fed is operating under the principle that it’s easier to get forgiveness than permission. And forgiveness is just another means to the desired power grab it is seeking.
The Fed Uncertainty Principle is still my all-time favorite post.
Related Posts
On October 21, 2021 I commented A Fed Economist Concludes the Widely Believed Inflations Expectations Theory is Nonsense.
The research department had these two amusing quotes in its report.
- It is far, far better and much safer to have a firm anchor in nonsense than to put out on the troubled seas of thought. John Kenneth Galbraith (1958).
- Few things are harder to put up with than the annoyance of a good example. Mark Twain, The Tragedy of Pudd’nhead Wilson (1894)
December 24, 2024: Dear Fed, Please Shut Up Already, Stop the Forward Guidance
Danielle DiMartino Booth claims the Fed should be cutting more, not less. I have a different suggestion.
Since the Fed has no idea, it should stop forward guidance that the market front runs thereby amplifying the feedback looks discussed above.
More accurately, there should not be a Fed at all. It’s proven clueless.
Two additional quarter point cuts in FFR would total a 1.5 percent drop in rates since Powell began lowering short term interest. Powell had indicated the Fed would take rates to this level in October 2023. His statement came after Yellen had announced there was no liquidity in the Treasury Bond market.
Before Powell’s pledge, corporate investors had utilized market rate BTFP loans to invest in equities. Their funds only halted the fall in stock prices. The market rout was from hyped media reports that the failure of SVB would create a domino bank crisis. It was Powell’s commitment of a 1.5 percent reduction that set reduced BTFP loan rates. It incentivized institutional investors to arbitrage at the cheaper rate, and leverage their equity purchases. The added liquidity rallied major market indexes and Treasury Bonds, as it drained the $2T repo facility.
The stock market rally began in October 2023, with the rise in margin debt. The increase in S&P margin debt has eclipsed the surge after the pandemic, when the Fed flooded the economy in QE fiat. But overall market margin debt has lagged. A narrow rally in the indexes by professional investors.
One year BTFP loans ended March 2024. Corporate investors have reduced margin purchases at higher market loan rates than Powell promoted, and margin debt fell for the first time in February. The market rally seems to have topped.
Powell created an artificial rally in equities (and consumer sentiment) by giving corporate investors a ‘preview sale’ in FFR rates, through the BTFP loan scheme with former Fed Yellen’s Treasury. Using $2T in Fed repo for liquidity (previously acquired by QE, which cost the Fed billions in overnight interest).
Fed ease ahead!
The Chicago Mercantile Exchange’s (CME) FedWatch Tool tracks the probability of changes to the Federal Funds rate based on Fed Funds futures prices. According to the tool there is currently an 88% chance that the Fed will maintain its target rate at the May 7 meeting, a 74% probability of a rate cut on Jun 18, and an 82% likelihood of a cut at the July 30 meeting. The tool only considers months when the FOMC meets, not every month.
Fed Funds futures contracts, which can be traded up to five years in advance, expire at the end of each month based on the average Fed Funds Effective Rate (FFER) for that month. While the target range for Fed Funds remains 4.25-4.50%, the effective rate has been stable at 4.33%. The June contract is complicated, as it reflects 18 days at the current rate and 12 days at a potential new rate and the July contract includes just 1 day at the new rate.
A clearer picture emerges from the August contract, as the Fed does not meet that month, meaning the FFER should remain in effect all month. It is currently trading at $95.965, which implies a rate of 4.035% – a reduction of 0.295%. For most interest rate contracts, the implied rate is calculated as 100 minus the contract price.
The market is pricing in a 100% probability of a 25-basis point cut before August 1, with an additional 18% probability of a second cut (0.295 / 0.25 = 118%).
Long time fan, Mish.
Yes. Fed needs to say less. The Obama admin became fascinated with “the nudge” as a behavioral control. Samantha Powers, one of Obama’s witches of Eastwick and USAID slush fund queen, married to Cass Sunstein, Dem political operative who also penned “The Nudge” about behavioral influence. But with Covid the FED did eternal repetition of the same but in tandem with fiscal fantasy spending. Fiscal needs less influence (Doge em) and Fed needs to shut its trap. Heisenberg is a nice analogy for self reflexive markets, a collective consciousness.
Informative article. Great points. I agree.
I guess the market thinks the economy is headed lower and expects the fed to have to jump in and cut rates, and of course my boy Trump will be leading the charge. I am worried about continued inflation and supply chain issue costs.
And money does seem to be leaving the U.S. market if that influences this?
Gold made a new all-time high recently despite interest rates pulling back and the economy expanding at a slower rate. Gold is calling the FED and bond market’s bluff.
The fed needs to INCREASE rates! Inflation is still too high. The inflation numbers coming from the government are BS.
Cool. Now you thumbs up / down is even.
I agree. Put the 100 BP back.
If the Fed cuts rates the cost of borrowing short terms will drop. Banks lending will rise after volatility subside.
What is the world where inflation doesn’t continue to be a problem.
I don’t care what the Fed’s surveys tell them, in the real world inflation of things people actually have to buy is way too high and well beyond any 5%.
Interest rates should not go down until they stop printing/credit expanding
When will they actually do THAT?
Two Trump haters, Carney and Pierre Poilliviere will compete with each other in Canada on Apr 28
The FED’s current ham handed means of trying (and failing) to control inflation is so spectacularly stupid and inept that its amazing that libertarians like Mish resist the way to resign not only inflation to the dust bin of history, but to accomplish beneficial deflation (which is what they say they’d like to see)…and an actual paradigm change with a single policy of a 50% Discount/Rebate at retail sale. Well, thats what happens when you simply think in an orthodox fashion instead of examining the concepts behind our systems in order to bring about actual and resolving change.
Fix the global economy with this weird trick!
Yes, if every nation did it, it would indeed be a global economic paradigm change.
The Fed and the markets have become co-dependent. The markets are always forward-looking, and the Fed needs to be forward-looking, given that monetary policy actions impact the economy with a lag of up to six months to a year. But, I agree with Mish that the Fed has become too communicative in its desire to push and pull market expectations. The Fed has come a long way from the primitive time of Volcker when the Fed did not communicate until well after the fact. If one looks at what Volcker did from an interest rate policy standpoint from 1979 to 1982, you have no real discernable strategy; he yo you’d interest rates two and three hundred basis points at a time from quarter to quarter, looking for something that would work. It was extremely crude compared to today’s Fed. All this being said, I think two or three rate cuts this year will likely prove necessary given what is being thrown at the economy and job market.
Friedman’s plucking model was right all along.
Jojo predicts Fed interest rate INCREASES in June and September.
Too soon to say. Do people know if Trump will be inflationary (like last term) or disinflationary this time? Or hyperinflationary even? Even at his hands are the keys to another great depression. He is not treading lightly on people. It really is an impossible task to try predict unless one gets access into the inner workings of the plan of the plan of the plan.
Trump will again be inflationary, as are most Presidents. However, automation/robotics/AI that replaces human workers is highly deflationary. Which will predominate?
Yes, you are correct, Trump will be inflationary in the end. But we’re all in for a good long trade war unless of course….well it’s all up to one guy. In the meantime inflation is an unhealed wound on people today, there is little room for more. People have now understood it’s a permanent removal of purchasing power. Only the percentage increases are transitory, the damage is permanent.
The great replacement by AI will go about as well as offshoring IT did.
Like Scott Bessent I look at the 10 year. If Trump and Musk can loop off enough of the fiscal deficit then we are in a new ballgame. Then rates where business borrow go nicely down and the short end follows. My fingers are crossed.
I wouldn’t count on that “new ballgame”! The savings so far are minimal, at best.
They have just got started, been there only a bit over two months and you complain they haven’t done enough. let’s see again at the end of the fiscal year before concluding anything.
What have they done lately?
Musk is going on tv with his boo boo face, and making car commercials with trump.
Trump will not wait that long to cut rates to zero. His billionaire friends have spoken. The lazy, distracted US population will sell everything to the billionaires that they will pay for with free (0%) money, and US will become feudal.
A stupid system, for a stupid people. It tracks.
After decades of globalization onshore is back. The banks will finance this activity. When they do: “Reserve Bank”, which are down since May 2022, will rise to a new all time high. The gov will stay out of the way. Gov debt will shrink while banks assets will rise. Gov debt/GDP will plunge.
In a recession, lending becomes riskier because the overall market is less stable. That risk induces interest rates to increase. But increasing interest rates only deepens recessionary forces. The Feds primary responsibility is to provide liquidity to banks in a recession to reduce the level of risk. The reduced risk and increased liquidity reduces interest rates, allowing the market to pull out of the recession. Conversely in an inflationary environment, risk is lower as asset values increase putting downward pressure on interest rates. So the Fed takes actions to increase interest rates to slow growth and inflationary forces. Unchecked inflationary forces eventually destabilize markets causing recessions. So the Fed’s role is to always counterbalance the natural tendencies of a Free “banking” market, because the natural positive reinforcement in lending cycles are highly detrimental to long term business investment. Which is why treating bank lending as a different subject outside of free market ideology lead to the greatest era of economic growth in human history. All of this is not to say that that the Fed doesn’t make mistakes. Just keep in mind that the world would likely be far worse without it. I’ll trade 3% inflation for 25% unemployment and my bank folding with my money any day.
Governments are selling US Treasury bonds. Tariffs likely hike inflation. Congress critters kicked the inflationary budget can. Corrupt Federal District Court judges stalled DOGE savings until the Supreme Court rules. Jerry Powell is hostile to MAGA & Trump.
Since the Fed raised EFF in Dec 2022 to 5,33% it’s total assets and it’s short terms lending to banks and financial institutes are both down. Its supply to private entities which supported gov spending, earning 4%, is down. Dealers and brokers are risk averse after losing billions in 2008 and 2009. Dealers reduced their assets, after they reached a new all time high, bc they are very nervous. QT is slowing down. The Fed cannot turn around from QT to QE on a dime.
4% after taxes is 3%, before 3% inflation. Most boomers are over sixty four, Will u still feed me when I am 64 ?
Banks don’t lend deposits. An increase in bank-held savings reduces GDP. But C-19 is different. There’s been a “flight to liquidity”. The ratio of DDs to TDs has doubled. There will be no recession.
This is my 3rd time series. And my least reliable. But there seems to be a confluence of inflection points around the end of April. The recent drop-in rates will be reversed in spite of the Treasuries’ ability to drain its account with the Reserve bank, and in spite of the need to replenish it in August?
Long-term interest rates hover around (1) long-term money flows, which turns up then. And the (2) moving average of long-term money flows also rises at the same point as the (3) 3rd seasonal inflection point, May 5th (my birthday).
And the markets forecast for future fed interest rate cuts as about as accurate as the fed themselves.
Remember, inflation is “transitory.”
The Fed’s job, IMO, is like trying to steer history;s biggest and most complex aircraft carrier, into often shifting, severely unpredictable weather patterns, with extreme shoals on both sides. It must err on the side of looseness (inflation) or else risk rigidity, careening into extreme crashes (every 20 years, pre-Fed 1800’s, each lasting for years: 1819, 1837, 1863, 1893). There will be a certain amount of Fed undershooting or overshooting most every time. It is the inherent nature of the situation. Easy to criticize every time, but what are the alternatives? Run credit and money out of a sports gambling app?
That’s right. And I think the markets are making another mistake.
Permanently transitory
We’ve got 3 more Core PCE readings between now & June. Then we have 3 more before September. We’ll know by June how many are on tap. Right now, it’s still very hard to tell, IMHO. I’m not surprised that the 2 cuts is below 50%. I don’t think Powell wants to give in to Trump’s pressure campaign, so I feel confident that he will need very solid data to point the way to further cuts. Hopefully, the CA & MX tariffs will wind down by June as well. If so, then I ‘d say a June cut becomes an almost certainty.
I think Trump may cave on some tariffs but the immigration enforcement and changes in visa programs remains to be seen. Remember the primary reason he was elected because of rampant immigration and inflation. Until the citizens of the country start doing better , Trump will be expected to keep deporting those on work visas after people who are here illegally get deported. I didn’t vote for Trump but as a citizen I fully support him in this. In the end we need some permanent deflation that can only come imo by reversing about 15 years of rampant immigration. By the way I didn’t agree with much of what either party was saying but now am seeing the method to Trump’s madness.
It feels like a lot of changes may be coming by summer to reverse the flow of immigration.
The way out of inflation, i.e., the way to deflation (lower prices), would be from increased productivity, and the producers passing on those savings to consumers. This happened in the 1990’s-2000’s with lower labor costs, when east Asia industrialized, and cheap labor was imported to the USA (by immigration). The OPPOSITE is throwing this into reverse: cutting off low-cost access to that foreign labor by tariffs, and cutting off access inside the USA by stopping immigration. That means labor prices as an input will rise, a supply shock. So, consumer prices go UP: inflation, not deflation. It may be good or right for various reasons, but it does not fit your logic, right? The only other alternative I can see is a positive productivity shock from robots, but this means broad wages/incomes go down, while corporations, high tech employees and stockholders maybe have wealth increases. None of that fits your scenario. Respectfully, I’m not trying to bicker, just clarify.
When wages are counted, none of the people who are long term unemployed counts. That blows a huge hole in whatever theory there is that there is wage inflation. The best case scenario for citizens is to stop immigration and retrain people for jobs of the future. We don’t need any more immigrants and I say that as an immigrant. The last 35 years of immigration have really only brought huge inflation and demand of everything outstripping supply.
Was anyone thinking about it on March 23, 2020?