The Fed may still cut rates once more this year, but beyond that it is not clear why the Fed should ease any further. The S&P 500 is at record highs, Bitcoin has surged, high-yield credit spreads have tightened to their narrowest since mid-2007, and core inflation has plateaued above the Fed’s 2% target.
Any additional easing of monetary policy, beyond December’s (still) likely rate cut, will simply risk a further sell-off in the long end. The policy rate is likely very close to neutral. Jerome Powell’s more ‘hawkish’ comments yesterday, were entirely appropriate, but he may have to go further. The election of Donald Trump to a second term, may give the Fed chair cover to pause rate cuts in 2025.
The S&P 500 hit the 6,000 mark, but is down over the past few days. So far this year, most of the rise in long-dated government bond yields has been a function of stronger growth, and a repricing of the terminal rate (higher). It makes sense that stocks have outperformed bonds in this environment.
However, the latest selloff in long-bonds is a warning. The US Treasury is heavily exposed to higher-than-forecast real yields. This was highlighted in the latest monthly Treasury statement: net interest outlays hit a new high of $886bn in the twelve months to October, climbing to a record 20.2% of total government receipts.
Paradoxically, a more hawkish Fed is more bullish for the stock market. The rise in long-dated bond yields needs to be capped. This could pressure the stock market in the short-term, but presents a more favourable, medium-term path. The alternative – a looser monetary and fiscal policy – risks a further sell-off in the long end, which will ultimately force the Fed to have to hike rates to pin the long end down, which will be more painful for stocks.
