The big question today was could the Federal Reserve (Fed) manage market nervousness following the softer-than-expected inflation data. Prior to the meeting, the market received the US inflation data, which were benign and lower than expected, catching the market somewhat by surprise and resulting in a 17 basis points rally in short-dated bonds.
Over the last few months the treasury market had almost given up on the idea that the Fed will cut anytime soon and this was perhaps a ‘shot across the bows’ that the economic winds may be changing.
However, as expected, the Fed left rates unchanged and produced a set of ‘dots’ (a chart indicating how Fed policymakers see interest rates rising or falling in the future) that were partly a reflection of ‘conservative’ inflation forecasts. In the previous chart in March of this year, the committee showed it was expecting three cuts in 2024 and a further three in 2025. They now expect one rate cut in 2024 and four cuts in 2025, this backed by an upward revision to the inflation forecasts. They also revised up their longer-term rate forecast which now sits at 2.8%. Perhaps hawkish you may say?
Chairman Powell and the ‘dot plots’ tried to steady the ship by highlighting that more members of the committee expected two cuts this year and that inflation was making further progress towards the 2% target, which is more confident than they were in the previous meeting. All in all this was a masterclass from Powell in aiming to keep markets stable. There has been a lot written of late about reduced liquidity in treasury markets, so Powell did well to navigate the bond market through some choppy forecasts and messaging.
The US two-year treasury started the day at 4.83%, fell to 4.66% on the CPI miss and then ended the day at 4.75%, so settling in between the extremes. This ties in well with the market’s view on expected cuts for the rest of this year with the markets priced 50/50 on whether we get one rate cut or two. Only time will tell, but one thing we are confident about from today’s showing is that the market will react much more to softer data than it will to strong, which is why we are still keen to err on the long side of duration within funds.
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