One Wall Street economist has a reminder for investors ahead of next week’s Federal Reserve meeting: don’t get too excited about the prospect of interest-rate cuts next year.
That is because the market’s perception of what the Fed might do over the months and years ahead is often incorrect — sometimes wildly so. While traders often have a good idea about what the Fed might do at the next meeting, beyond that, it is mostly guesswork.
In his latest note to clients shared with MarketWatch on Friday, Apollo Chief Economist Torsten Slok compared futures-market pricing of expected changes in the Fed’s policy rate target with how the fed-funds rate has actually moved over time.
Sometimes, the market at least gets the directional move right, but traders expectations have been dashed far more often than they have been proven right over the past 15 years.
For example, investors were right to start pricing in interest-rate hikes beginning in 2014 when the Fed, at the time led by former chair and current U.S. Treasury Secretary Janet Yellen, started raising borrowing costs for the first time since the 2008 financial crisis. But at least initially, they expected the Fed to act more aggressively than it ultimately did.
Between 2009 and 2014, traders repeatedly saw their expectations for a rapid normalization of monetary policy dashed as the Fed kept rates at the zero bound longer than most had expected.
Ultimately, the Fed opted to interest raise rates much more slowly and carefully than many traders had expected.
Traders were proved wrong again when the Fed, this time under Chair Jerome Powell, started cutting interest rates for the first time since the financial crisis during the summer of 2019. This time, traders failed to anticipate how quickly rates would fall — although the advent of the COVID-19 pandemic played an important role with this.
Since the Fed started raising interest rates again in March 2022, the market was caught off-guard when it failed to anticipate the pace and magnitude of the hikes. Since then, traders have been repeatedly disappointed in their hopes for a Fed policy “pivot.”
After penciling in cuts to begin around the middle of next year, traders risk being disappointed once again, Slok said, given the Fed’s insistence that it plans to keep interest rates higher for longer to quell inflation.
While traders are once again betting on a Fed pivot, the central bank’s latest dot plot summary of interest-rate projections shows senior officials expect to keep the policy rate north of 5% until 2025.
“When rates are low, the market is systematically pricing that the Fed will soon hike,” Slok said. “When rates are high, the market is systematically pricing that the next move from the Fed is to cut.
“Maybe the Fed will cut rates next summer,” Slok continued. “Maybe not.”
“For now, investors should be planning on rates staying higher for longer.”
The Fed is set to deliver its next decision on whether to raise interest rates, or leave them steady, after its two-day November policy meeting concludes on Nov. 1. Fed funds futures traders overwhelmingly expect the Fed will keep rates on hold next week, assigning a 99.5% probability, according to CME’s FedWatch tool.