Markets Aren’t Always Right About Rate Cuts

Many in finance have been publicly arguing that the Federal Reserve would soon cut its benchmark federal funds rate, leading to cheaper financing and increased stability everywhere, including commercial real estate. But sometimes markets get things wrong, and some voices are saying that this is one of those times.

One indicator of market expectations is the falling yields of longer-term Treasurys. As of Wednesday, December 6, the 10-year was at 4.12%, seemingly moving downward to the sub-4% levels seen earlier in 2023. The 30-year was at 4.22% in an ongoing move downward from its recent mid-October high of 5.11%. All would suggest that investors were betting on lower future interest rates.

Experts have recently been predicting that the Fed would be forced to back off its higher rates, even though officials at the central bank have continued to say they were in no rush, waiting to see how data developed. Deutsche Bank economists expect a 175-basis point retreat. Wall Street has geared up for cuts. Pershing Square Capital Management CEO Bill Ackman thinks the Fed might start cutting rates as early the first quarter of next year.

CME Group’s CME FedWatch Tool suggests that by the December 2024 meeting of the Fed’s Federal Open Market Committee meeting, there is a 66% chance of at least a 125-basis point drop from the current 5.25% to 5.50% range.

But the “markets dictate” view set up a bad experience for the Fed in 2018 when it raised rates four times, each by a quarter point, and investors reacted by selling off equities. Throughout the last 20 months or rate increases, the central bank has continued to stress that it would have to see lasting evidence of a sufficient reduction in inflation to change its strategy.

“Market pricing for rate cuts is a bit overdone in our view,” Wei Li, global chief investment strategist for BlackRock said to Reuters. “Rate volatility is here to stay.” He further said the firm sees structurally higher inflation and that it would be difficult for longer-term Treasurys to fall from current levels. However, BlackRock also thinks that the Fed has already reach peak rates, with no increases likely as well.

The Financial Times recently polled “leading academic economists” who expected no rate cuts before July 2024 and thought that any would provide less of a pullback than financial markets expect — on the order of a half percentage point.

“I still see a lot of momentum for the economy, so I don’t see a need for lowering rates right away, and I don’t think the Fed plans to do that either,” James Hamilton, a professor of economics at the University of California in San Diego who participated in the survey, told the Financial Times.