In a recent interview with The Wall Street Journal conducted by Nick Timiraos, Fed governor Christopher Waller stirred up quite a debate that has further fueled expectations of the Fed adjusting the fed funds rate throughout 2024.
Waller introduced the possibility of rate cuts as early as March, highlighting the economic arguments derived from the standard Taylor rule. According to him, if lower inflation persists for several more months—perhaps three, four, or even five months—it may provide the confidence needed to start lowering the policy rate due to the declining inflation.
Market indicators also align with this view, as seen in the pricing of the upcoming FOMC meetings. The March FOMC meeting, just three months away, is pricing in a 9-basis point cut, reflecting a 36% chance of a 25-basis point reduction. In May, the FOMC meeting is expected to result in a 25-basis point cut (100% probability), and by June, there’s anticipation of a 39-basis point cut, equivalent to 1.5 cuts. Looking further ahead, US SOFR futures are even pricing in a total of 115 basis points of cuts in 2024.
This shift in market sentiment has had a profound impact on the US Treasury market, particularly in the 2 and 5-year maturities. The 5-year maturity is approaching new trend lows, eyeing a move towards the 200-day moving average at 4.12%. US real rates have also declined significantly, signaling that as US growth cools, possibly to 0.5% by Q3, and the US labor market records average payrolls of 30-50k by Q224, real rates of 2.2% are no longer deemed necessary, and a range of 1% to 1.5% appears more appropriate.
The declining US bond yields, especially when compared to yields in European, UK, and Japanese bond markets, have made the US less attractive for investors. This reduction in the US yield premium has put pressure on the USD. Additionally, factors like a lackluster 7-year US bond auction and systematic trend follower (CTA) flows have further contributed to this trend.
Waller’s statements have planted the seed for a potential shift in guidance from other Fed members. While the market has been positioning for rate cuts, this is the first time a core Fed member has laid out a clear path and credible timetable for easing. As a result, market watchers are now shifting their focus back to data analysis.
The upcoming US nonfarm payrolls (NFP) report will be of paramount importance, as the labor market holds the key to compelling rate cuts. With the 3-month average NFP currently standing at 204k, achieving a sub-200k average would require a NFP print below 150k, a challenging but conceivable scenario. Additionally, the unemployment rate, expected to remain at 3.9%, could trigger discussions if it rises to 4%, potentially invoking the SAHM recession rule, though skepticism about its current efficacy persists.
Looking ahead to November, the US CPI print will be closely watched, especially given the market’s reaction to the October CPI data, which triggered a wave of USD selling. Expectations are for a 0.1% month-on-month headline CPI and 0.3% month-on-month core inflation, with precision measured to two decimal places. A core CPI print below 0.25% could lead to further USD selling, and the possibility of a negative month-on-month headline CPI print would certainly stir market conversations.
From a risk perspective, considering the richness of rate expectations and the recent USD decline, it’s important to note that the USD may become highly sensitive to positive surprises in US economic data, potentially sparking a wave of USD short covering.
While month-end flows may continue to impact the USD, many traders are looking ahead to December and positioning themselves for a potential short-covering rally. However, a sustained rally will likely hinge on factors like a higher USDCNH, rising US bond yields outpacing other sovereigns, and increased cross-asset volatility. All eyes will be on the NFP and CPI reports, making these key dates for traders to mark in their calendars.
