Why Fed rate cut direction may matter more than timing

Thu, Nov 30, 2023, 10:44 AM

BMO Wealth Management US CIO Yung-Yu Ma argues "direction matters more than the timing." With markets revealing lower rate expectations, easing of financial conditions will translate into the real economy through things like borrowing costs. So while the market-implied inflation path likely "will not pullback too far" below 2% immediately, Ma believes sustained cooling momentum remains key.

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Video Transcript

- Good to have both of you on today. Greg, I'm going to start with you, with that question that Jen just raised, which is, is this latest print enough for the Fed to say, yes in fact, we do fear feel comfortable keeping rates where they are right now?

GREG DACO: I think so. I think we're seeing increased evidence that the disinflationary process is well underway. We are in an environment where we're seeing gradually cooling final demand for goods and services, we still have more disinflation coming from the rent sector, and we have monetary policy that's restrictive. That's the ideal combo to continue pushing inflation lower.

We've been saying for quite some time now that inflation will fall faster than the Fed has been anticipating. This is now materializing. So we're anticipating by early next year, we'll be close enough to the Fed's 2% target to start talking about rate cuts. And we think the first rate cuts will come in June. So yes, we are on this right trajectory.

- And Yung-Yu Ma, I want to bring you in here because we've seen a lot of analysts agreeing that perhaps second half of 2024 is when we could see rate cuts, even though the Fed speak saying something slightly different. But you say the direction matters more than the timing. Break that down for us.

YUNG-YU MA: That's right. We do think the markets will key off of the Fed's main message that will evolve in 2024 to be a trajectory of rate cuts and a softening message before that. And whether or not there are two rate cuts, three four, we think that's less important. And even the timing is somewhat less important if it takes place in May, June, or later in the summer. Really the direction for the markets is what's going to be helpful and help to shift psychology. And also help to lower borrowing costs in advance of those rate cuts.

So we're pretty optimistic. We think that was a very nice print that we saw this morning. If you look at the month over month numbers, which we like to focus on for the trend, those look very attractive and sort of trending toward that 2% level. Maybe not quite there, but at least trending in that direction.

And we do think this gives the Fed some confidence to ease off of its messaging in December. But it's not going to pull back too far. It does want to still message that there's more data that needs to be seen, more confirmation. So we do think the Fed is going to temper the market's expectations a bit. But the trajectory is what matters the most.

- Greg, where do Treasury yields factor into the Fed's decision making-? Going into that last meeting, so much of it was about the rapid rise of those yields. We're still-- we're well off that talk about a 5% on the 10-year or the 30-year yield. But does the decline that we've seen since, does that complicate the decision making for Fed officials?

GREG DACO: It might on the margin. I know there was a lot of discussion as to what had initially prompted the rise in the 10-year yield towards 5%. The question of whether this was an implicit assumption that the Fed would have to do more tightening in order to bring down inflation. Or whether this was an indication of the term premium being on the rise.

I think what we're seeing right now in markets is essentially this expectation that the growth momentum is slowing. That the economy will advance at a slower pace. Not a recessionary pace, but a slower pace into next year. That inflation is moving in the right direction, as we were just discussing. If you look at three-month or six-month annualized measures of core inflation, we're at 2.5%. So that's close enough to the Fed's target.

That's what's being priced into markets. I don't necessarily fear that this easing of financial conditions is going to spur faster growth that would otherwise be inflationary. On the contrary, I think what we're seeing is a reflection of a slower environment where disinflation is continuing to progress at a fairly steady pace. And that we're moving in the right direction to allow the Fed to ease monetary policy gradually.

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Why Fed rate cut direction may matter more than timing

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