Moneycontrol Pro Panorama | The more the Fed gives, the more the market wants

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Fed chair Jerome Powell and the Federal Open Market Committee finally delivered on the much-awaited pivot in the policy rate.

But the Fed Funds market was already sceptical of Powell’s rather dubious ‘’higher-for-longer’’ stance and had pencilled in rate cuts amounting to 100 basis points by December 2024, even before the latest FOMC announcement. In other words, despite the September 2023 FOMC members’ median estimate of the target Fed Funds rate being 5.1 percent by December 2024, the Fed Funds futures market, as on 6^th December 2023, was pricing in the probability of the policy rate being 400-425 basis points or lower in December 2024 (Please see accompanying chart).

The FOMC now says its median estimate for the Fed Funds Futures rate in December 2024 is 4.6 percent, which implies 75 basis points of rate cuts. That is still higher than the 4-4.25 percent priced in before the Fed announcement on 6^th December.

A section of the market, looking at the runaway rallies in the equity and bond markets and the consequent easing of financial conditions, had expected the Fed to sound hawkish, which is why there was a bit of a pullback in the Fed Funds futures market a day before the announcement. But the probability was still a huge 76.7 percent that the Fed would be forced to cut its policy rate to 4.5 percent or below by December 2024. So, most of the lower median estimate of the Fed Funds rate had already been priced in.

But the chart shows that, as soon as the FOMC acknowledged that the market was right, the market wanted more. After the FOMC announcement, the Fed Funds futures market now pencils in a 73 percent probability that the Fed Funds futures rate will be 375-400 basis points or below by December 2024. In short, it’s now expecting rate cuts of 150 basis points or more in 2024. The more the Fed gives, the more the market wants.

Fed chair Powell has fanned the market fires. So far, the assumption was that the Fed would cut rates only if a recession loomed ahead. But Powell now says the Fed doesn’t need a recession to cut rates. “It could just be a sign that the economy is normalizing and doesn't need the tight policy,” he said. Even a soft landing would lead to lower rates—it’s Goldilocks on steroids for the markets.

The markets are also pricing in faster rate cuts. They now expect a rate cut of 25 basis points by the FOMC as early as March 2024. Before the latest FOMC announcement, the betting was that the first rate-cut would happen in May—now there’s a 70 percent probability that the Fed Funds rate would be cut to 500-525 basis points in March and a 17 percent probability it would be cut to 475-500 basis points then.

To be sure, part of the rally was on account of the bears being caught unawares and the consequent short covering. But the equity markets are rallying hard to price in the new signals from the Fed Funds futures.

My colleague Anubhav Sahu has pointed out the implications of the Fed pivot for Indian investors.

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Manas ChakravartyMoneycontrol Pro