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The Fed has cut the Fed Funds rate by 1% since late 2024, and the presumption from many market participants is that the Fed has made policy less restrictive. Technically, they are somewhat correct. Banks and other financial institutions that borrow over very short periods have seen their borrowing costs decline due to the Fed’s actions. However, the Fed has indirectly made policy more restrictive for the vast majority of borrowers.
The graph below shows that despite the overnight Fed Funds rate falling from 5.33% to 4.33%, mortgage rates and the yield on the 10-year Treasury have risen about half a percent. Bear in mind that corporate and auto loans, as well as almost all other bank lending rates, are tied to the 10-year Treasury yield. Thus, these rates, too, have become more restrictive. Although not shown, the 5-year Treasury yield, which serves as a benchmark for shorter-term loans, is approximately 30 basis points higher than it was before the Fed began cutting rates.
Since the Fed cut rates, the economy and payroll growth have slowed appreciably. Inflation remains above the Fed’s 2% target but is near the same levels as when they started cutting rates. The critical takeaway is that, despite weaker economic growth and a pronounced slowing in the labor market, interest rates have become more restrictive. Instead of assuming that monetary policy is easier today than in 2024, the Fed and investors should consider that policy is actually more stringent for the vast majority of borrowers.
Corporate Bond Spreads
We just added corporate bond spread analysis. The screenshot below allows us to walk through what the new page tells us. For starters, all the data on the page represents the difference in yield between the various credit ratings of the BofA Corporate Bond Index and a similar-maturity US Treasury security. We highlight in red the data for BBB-rated bonds. On the top left, we can see that currently, BBB bonds yield 1.03% more than US Treasuries. The table to the right of that spread informs us the spread is historically tight. For example, over the last 20 years, the spread has only been lower than it is today 0.99% of the time. The graph to the right shows this as well.
The bottom two tables help us appreciate spreads between different-rated corporate bonds and how they have changed over the prior four weeks. Currently, BBB bonds yield 0.70% more than AAA-rated bonds. That spread is unchanged over the last four weeks.
Similar to sentiment in the stock market, this table indicates that sentiment in the corporate bond market is extremely bullish. As a result, spreads are well below average, leaving corporate bondholders, especially those in lower-rated bonds, vulnerable to a significant loss if spreads revert to their historical averages.
ADP Is Worse Than It Seems
ADP has proven to be a prescient indicator of the labor market. Over the past six months, ADP has shown a pronounced slowing of job growth. Until the BLS significantly revised its job growth figures lower last month, the BLS was pointing to a healthy jobs market. With the revisions, ADP and the BLS are back in sync. As we gear up for today’s BLS labor report, we should consider that yesterday, ADP reported the jobs grew by 54k. Such is below the 150k-250k run rate of the prior few years. More importantly, and often overlooked, the labor force grows by approximately 150k people per month on average. Thus, the recent average growth rate of 50k by the ADP and the BLS indicates that job growth is not keeping pace with the growth of the labor force.
The second graph below helps partially explain why the unemployment rate has remained stable despite job growth that is below the rate of labor force growth. The graph, courtesy of Trading Economics, shows that the participation rate has fallen by 0.4% over the last four months. This tells us that 0.4% of the population has left the workforce. Some people exit for legitimate reasons, such as retirement. Yet, others can’t find a job and stop looking. The point is that the unemployment rate is likely higher than the BLS claims would be if not for the declining participation rate. We may learn this in months and years from now as the BLS revises its data.
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