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In early November, markets were moderately confident that a slowing labor market would persuade the Federal Reserve to cut interest rates for a third time at the Dec. 10 policy meeting. But confidence on that bet is unravelling amid concerns that inflation may not be as benign as recently expected.
Fed funds futures are now pricing in a below-50% probability for a rate cut next month, down from roughly 70% earlier this month, based on Fed funds futures.
“What we’ve really seen is that there is a lot of reticence to cutting aggressively given all of the unknowns out there,” said Diane Swonk, chief US economist at KPMG. “There is also some inflation coming from the services sector that has just not been eradicated,” noting that there had been “a lot of wishful hoping.”
It’s not yet clear if the Treasury market is buying into the attitude adjustment. Although the 10-year yield has rebounded from its October low of roughly 3.95% to 4.15% at Friday’s close, the benchmark rate continues to trade in a tight range since September, and a sliding trend year to date is still conspicuous.
Meanwhile, the policy-sensitive 2-year yield continues to trade well below the effective Fed funds rate – a market signal that suggests the bond market is still anticipating rate cuts.
A modest decline in real (inflation-adjusted) Treasury yields via the TIPS market vs. recent history also suggests that inflation concerns continue to be downplayed.
A new paper published by the San Francisco Fed provides cover for the doves, arguing that higher tariffs slow economic growth, raise the jobless rate and lower short-term inflation, based on analysis of 150 years of economic history.
Perhaps the latest reluctance to fully price in more rate cuts is bound up with uncertainty fueled by delayed government data. But the mystery will begin easing as economic reports start flowing again now that the federal offices have reopened. As fresh numbers start arriving in the weeks leading up to the Dec. 10 Fed meeting, markets will be in a better position to reassess the state of the economy and inflation.
This week’s key update: the delayed payrolls report for September from the Labor Department, scheduled for Thursday, Nov. 20. The consensus point forecast sees hiring rebounding modestly, rising 50,000 from August’s sluggish 22,000 advance, based on Econoday.com’s polling.
Even if the forecast is accurate, the news will reaffirm that the labor market has slowed dramatically since the first quarter, when payrolls rose by an average of 111,000.
The question is whether incoming inflation data will be sufficiently above expectations to override the ongoing concern that hiring is downshifting. For the moment, Wall Street is repositioning closer to a neutral view as it awaits new numbers.