Is the Fed Behind the Curve?

The futures markets have been aggressively pricing in rate cuts but the Fed has only signaled for 30 basis points in cuts next year… so far.


The Fed Has Shifted Dovish

Indeed, the last Fed meeting saw policymakers shifting to a more dovish outlook toward the US economy. There was even one Fed member who was ready to cut 25 basis points in June. But Powell didn’t send the same message across in the press conference.

He noted that Fed members were leaning more towards a cut rather than a hike and mentioned that a close eye will be kept on deteriorating US economic data. However, he only signalled about 30 basis points in cuts, and that too in 2020.

The Futures Market is a Lot More Dovish

According to the CME FedWatch Tool, there is a 100% probability that there will be a rate cut next month. That’s not a type, the markets believe the odds of rates remaining where there are now are at 0%. They’ve gone further by pricing in a 40% chance of a 50 basis point cut in July.

At this point, there is a huge discrepancy between what the Fed is telling us and what the futures markets are thinking. Considering how aggressively a rate cut is priced in, it seems very likely the Fed will converge to the market rather than the other way around.

This emphasizes the importance of Fed Chair Powell’s speech that is scheduled for later today. The Fed rarely makes a move without proper communication. This ensures limited volatility in the markets, something that is very important to them. If Powell decides to convey intentions of a rate cut, today’s speech might be the right time.

Rate cut expectations have been the primary driver for the recent bout of dollar weakness, the decline in Treasury yields, and of course the surge in gold. It can be argued that safe-haven demand has increased because of geopolitical tensions as well. In this context, today’s speech might just fuel the next leg higher in gold prices.