As expected, the FOMC left the Fed Funds corridor unchanged on Wednesday. Mildly surprising to us though, their economic forecast continues to indicate that they expect to cut the overnight rate three times this year. As we’ve written on numerous occasions, the job market remains robust, and the consumer price index has stabilized at the mid-3% level, well above the Fed’s stated target. The question being asked, is there an imminent threat to economic growth that the Fed is aware of, but the rest of the investing community is not? Especially since a popular financial conditions indicator, which aggregates broad financial conditions such as interest rates, equity prices, and credit spread is showing that financial conditions have eased since last fall. Why then is the Fed threatening to ease policy?

At first glance the employment report for February was surprisingly strong. The expectation was that the economy would add 200,000 new jobs, up from an expected 188,00 last week. The actual change in payroll was 275,000. The year-over-year change in average hourly earnings was 4.3%, 0.1% lower than it registered last month but still an impressive uptick.

This was a quiet week for the fixed income market, with the entire yield curve closing within a few basis points of last Friday’s close. The only real action came between late Wednesday afternoon into today’s close, as investors digested the minutes of the January FOMC meeting. As expected, the minutes echoed Chairman Powell’s post-meeting press conference comments that communicated that a rate cut was not imminent. That was enough to push the long bond up to 4.48%, the highest yield so far this year. Contributing to the rise was initial claims for unemployment insurance which totaled 201,000 for the week. That was the second lowest tally of 2024 and further evidence that the economy is not poised to enter a recession. But that wasn’t enough to offset dip-buying on Friday. On the week, the 30-year bond closed six basis-points lower, finishing at 4.37%.

As expected, with the light economic data calendar, volatility driven by data this week was nearly nonexistent. Instead of trading on economic data, traders focused on the plethora of Fed member speeches, 15 of them, with a Fed speaker hitting the tape every day this week. The message was consistent, reflecting Chairman Powell’s comments that the Fed is likely to cut rates this year, but not imminently. There was also some limited discussion about the effect seasonality could have played in the outsized January employment report. The problem with that discussion is that they don’t want to call the integrity of government reporting into question for many reasons. The primary one being if the data is flawed and they are making decision on flawed data then, inherently, the decision is flawed. As the rates market realized that the Fed might not be as early and as aggressive as it thought, yields rose with the intermediate sector of the yield curve suffering the largest increase.

Three years ago, the watchword was “transitory inflation;” that was followed last year by “higher for longer.” On the back of the Fed’s communication that they expect to cut rates three times this year, the new watch word on the street is “wait and see.” The reason for the uncertainty is the moderation the economy has displayed. Inflation has drifted lower, the jobs market remains robust, and consumers continue to consume. In short, the economy appears to be in equilibrium. Given that circumstance, the Fed should not be in a hurry to cut rates. Except that the real estate market is being negatively impacted by relatively high interest rates. The residential market is clearly being hampered by high mortgage rates, but the concurrent shortage of inventory has prevented a collapse of home prices. But commercial real estate is not enjoying the same dynamic. In addition to higher borrowing rates, commercial real estate continues to be challenged by the hangover of the COVID-related work from home mentality. While lower rates would help offset some of the expense of excess office space, we expect that the sector is in the early days of a years-long retrenchment.