A bold move by the Fed: Unraveling the FOMC's recent decisions and their impact
The Federal Open Market Committee (FOMC) has left markets with a lot to unpack. As expected, they cut rates and ended quantitative tightening (QT), but the story doesn't end there. It's time to dive into the details and explore the potential consequences.
Key Takeaways:
- The FOMC's rate cut and QT end were anticipated, but the dissents and Powell's comments have sparked debate.
- Despite Powell's reticence, we still believe a December rate cut is likely, given the labor market's slow deterioration.
- Funding markets remain under pressure, and the Fed's decision to redirect proceeds from its asset-backed securities portfolio has implications.
- The use of the standing repo facility (SRF) has increased, indicating potential liquidity strain.
- Temporary open market operations (TOMOs) could be on the horizon if funding market stress persists.
EXHIBIT #1: DECLINING ODDS OF A DECEMBER RATE CUT
The odds of a December rate cut have taken a notable dip, as shown in Exhibit #1. While the FOMC's decision last week was expected, Fed Chair Jerome Powell's comments at the press conference left markets questioning the likelihood of further cuts. He described a third consecutive cut as not a certainty, which has led to a shift in market expectations.
EXHIBIT #2: A LESS AGGRESSIVE EASING PATH
Exhibit #2 illustrates the market's revised expectations for the rate path. The swaps market now predicts a less aggressive easing cycle, with a lower probability of rate cuts in the coming months. This shift is a response to the Fed's recent messaging and the evolving economic landscape.
The Fed's Dilemma: Navigating Uncertainty
The Fed finds itself at a critical juncture, facing an uncertain economic environment due to the government shutdown. Powell acknowledged the tension between the Fed's dual mandate goals, with strong views across the committee. The decision on December's rate move is still up in the air, and the Fed will be closely monitoring the data to assess the outlook and balance the risks.
Labor Market Deterioration and Inflation Concerns
We believe the labor market is slowly weakening, and this trend is likely to become more apparent as alternative data sources emerge. Additionally, the concern over inflation not reaching its target level is shared by some committee members. A dovish policy aimed at addressing the labor market could potentially impact inflation, as Powell has warned. However, we anticipate that the employment aspect of the mandate will remain a priority, leading to another rate cut on December 10.
EXHIBIT #3: FUNDING MARKET PRESSURE PERSISTS
The Fed's decision to end QT and redirect proceeds has not alleviated funding market pressures, as evidenced by Exhibit #3. Financing rates continue to exceed Fed reference rates, indicating potential challenges in the market. The move towards an exclusively treasury portfolio and reducing the weighted average maturity of holdings aims to address these issues, but the strain on liquidity persists.
EXHIBIT #4: INCREASED USE OF THE STANDING REPO FACILITY
Exhibit #4 highlights the rising usage of the Fed's standing repo facility (SRF), as shown by the daily operations. The SRF, established during the pandemic, has seen more frequent use recently. This increase in activity suggests that counterparties are recognizing the benefits of borrowing from the SRF, especially when funding rates are higher than desired.
The Potential for Temporary Open Market Operations (TOMOs)
If funding market stress continues, temporary open market operations (TOMOs) could be the Fed's next move. As Dallas Fed President Lorie Logan suggested, the Fed may need to intervene to maintain an ample supply of reserves. TOMOs could help alleviate the strain and bring rates closer to the desired levels.
Conclusion: A Complex Path Forward
The FOMC's recent decisions have left markets with a mix of expectations and uncertainties. While a December rate cut is still on the table, the Fed's approach to funding markets and liquidity management will be crucial. As we navigate this complex economic landscape, the Fed's next steps will be closely watched, and the potential for further interventions, like TOMOs, remains a possibility.
And this is where the story gets even more intriguing... What do you think? Will the Fed's actions be enough to stabilize funding markets? Share your thoughts in the comments!
