Is an Interest Rate Cut on the Horizon?
For the past two years, the general trend in the federal funds rate has been upward. That trend has been expected to continue through 2019, as the Federal Reserve continues its path of incremental increases after nearly a decade of near o% interest rates.
However, although the old saying “what goes up must come down” doesn’t always apply in fiscal policy, Bloomberg News reports that some of the most accurate gauges of economic health are pricing in lower Fed rates for the first time in more than a decade.
The near-term forward spread, a little-known metric that reflects the difference between the forward rate implied by Treasury bills six quarters from now and the current three-month yield, fell into negative territory this past Wednesday for the first time since March 2008. Two-year yields dipped below those on one-year paper in December.
“This is a crystal ball, it’s telling you about the future and what the market thinks of the Fed and what it will do with its policy rate,” Pimco’s Tony Crescenzi said in a recent interview with Bloomberg TV. “The market is predicting a rate cut at the beginning part of next year.”
Economists at the Fed have recently pointed out that looking at forward rates relative to those on current Treasury bills has served traders well in the past.
“When market participants expected—and priced in—a monetary policy-easing over the next 18 months, their fears were validated more often than not,” the Fed’s Eric C. Engstrom and Steven A. Sharpe wrote in a research paper last July.
When the near-term forward spread turns negative, it indicates bets on easier policy “over the next several quarters,” Engstrom and Sharpe wrote. Presumably, that’s because market players “expect monetary policymakers to respond to the threat or onset of a recession.”
Bloomberg reports that money markets have been paring back expectations of rate hikes as economic data weaken and equities are buffeted by opposing forces. Recently, traders have priced in no movement in the federal funds rate this year, and more than a 50% chance of a rate cut in 2020.
“We won’t be roaring into the 20s like we did a hundred years ago,” Crescenzi told Bloomberg. “We could be stumbling into the 20s, is what the market is saying.”
For comments, questions or concerns, please contact Paul Bubny
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