FOMC preview: challenging the March dot plot. FOMC preview: challenging the March dot plot. FOMC preview: challenging the March dot plot.

FOMC preview: challenging the March dot plot.

Bonds
Althea Spinozzi

Head of Fixed Income Strategy

Summary:

  • A hawkish pivot is probable at this week's FOMC meeting.
  • Powell is likely to emphasize the "high-for-longer" message, indicating that the Fed is not in a rush to begin cutting rates.
  • Emphasis on Quantitative Tightening (QT): Indications of a slowdown in QT can bolster bond markets. While the Fed maintains its hawkish stance, reducing the pace of QT means less selling pressure on US Treasuries.
  • The FOMC meeting is unlikely to bolster sentiment in bond markets, leading us to anticipate a further rise in long-term yields. Meanwhile, short-term yields are expected to remain anchored at their current levels.

Anticipated Impact of the FOMC Meeting on Bond Markets:

  1. Hawkish guidance: the Fed shows reluctance to initiate rate cuts and postpones QT tapering talks. Such communication could spur a bear-steepening of the yield curve. This scenario could propel 10-year yields towards the 5% mark, while 2-year yields might surpass 5% to find resistance next at 5.25%. However, a significant breakthrough beyond 5.25% for 2-year yields would likely necessitate a Federal Reserve shift towards hiking rates.
  2. Balanced guidance: the Fed conveys a willingness to delay rate cuts while hinting at imminent QT tapering. Bond markets may remain rangebound. In such a scenario, 10-year yields are expected to trade within a range of 4.58% to 4.73%, while 2-year yields are likely to hover around the 5% mark.
  3. Dovish guidance: If the Fed asserts its intention to implement three rate cuts this year and signals imminent QT tapering. Bond yields could see a decline. Under this scenario, 2-year yields might decrease to around 4.75%. Although 10-year yields could drop to 4.5%, they are anticipated to resume an upward trajectory due to the economy's resilience and persistent inflationary pressures.

How many rate cuts in 2024?

A hawkish pivot is probable at this week's FOMC meeting as markets challenge the dot plot's forecast of three interest rate cuts for the year, and policymakers are increasingly wary of persistent inflationary pressures.

Bond futures are currently pricing in a 35-basis-point rate cut by December, with only a 22% probability of a hike in July, just prior to the commencement of the US Election campaign. Additionally, OIS are indicating the likelihood of the first rate cut occurring on November 7th, two days after the election.

Market resistance against early and aggressive rate cuts stems from several key factors:

  • Strong US economy. The US economic landscape continues to show resilience with robust economic activity, supported by strong consumer spending despite increased price sensitivity.
  • The labor market remains strong, accompanied by positive real wage growth, which bolsters consumer spending.
  • Disinflationary trends have halted, with some indications of inflationary acceleration. Both the CPI index and core PCE have exhibited upward movement, with core PCE reaching a 4.4% annual rate in the first three months of the year, surpassing levels seen from 1990 to 2021.

Recent Fed communications have taken a hawkish tone, signaling a reluctance to ease monetary policy prematurely. Consequently, all eyes will be on Powell's press conference, with investors eager to discern whether policymakers are leaning towards fewer rate cuts than indicated in the dot plot.

Are discussions surrounding a slowdown in Quantitative Tightening advancing?

The significance of QT tapering cannot be overstated, as it currently holds more weight than anticipated rate cuts for several reasons:

  • Slowing the pace of QT would precede any rate cuts by the Federal Reserve. As the RRP diminishes and bank reserves decline, the importance of QT tapering becomes paramount for policymakers as they want to reach the level of ample/scarce reserves slowly.
  • QT tapering might delay interest rate cuts, making the “high-for-longer” message stickier.
Source: Bloomberg.

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