July 2024
Investors reacted to slowing economic data last month by taking interest rates materially lower. For July, the 2-year note closed the month 50 basis-points lower at 4.25%, and the 30-year bond closed 26 basis-points lower at 4.30%. Capping what has been a string of weak employment reports, the non-farm payroll measure for July showed the economy added 114,000 new jobs for the month, well below the 178,000 expected. Most alarming though was the unemployment rate, which rose to 4.3% in July. That’s 0.8% higher than the rate registered last summer and to some, a harbinger of a recession lurking just around the corner. We don’t share that concern, but the weak employment data paired with Chairman Powell’s words have made a September rate cut a foregone conclusion.
That gloominess carried over into the early August trading session and culminated when traders were greeted on the first Monday of August with panic emanating from Japan. Japanese investors fearful of the impact the Bank of Japan’s rate hike plans would have on the economy, sold their equity holdings furiously. The one day drop in value from the previous Friday was more than 12%.
The selloff had the earmarks of past panics, with the two-day loss on the S&P 500 registering more than 5%, but there was no real catalyst for the selling. The market recouped most of the losses throughout the week as investors bought stocks that had been shed days earlier.
To their credit, the members of the Open Market Committee remained silent as the selling unfolded. They have already communicated that the next move in the Fed Funds rate will be lower and that it’ll occur following the conclusion of the next meeting on September 18th.
Inflation in July moderated further, with the headline year-over year Consumer Price Index registering 2.9%, the lowest change since March 2021. We deem that change as being enough to support the FOMC plans to cut the overnight rate in September, but not enough to warrant a 50 basis-point cut. By cutting rates in increment 25 basis points moves, the Fed will avoid panicking the bond market. Already, the 2-year/30-year yield curve has gone from a 36 basis-point inversion to a positive slope of 18 basis points. In cutting rates, the Fed would like as much as possible to have a parallel shift in the yield curve. In other words, have long term interest rates follow short rates lower. The reason being is that the long end of the yield curve is going to influence mortgage rates, the segment of the economy that is most depressed. If they cut rates too fast bond investors will fear a quick return of inflation and steepen the yield curve and possibly cause mortgage rates to rise. If they’re moderate in their cuts, they are more likely to achieve the desired parallel shift with mortgage rates falling with the overnight rate. With that, we anticipate that they’ll engineer a 25 basis-point cut at each of the next three committee meetings.
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