Growing acceptance of the higher-for-longer theme for U.S. interest rates is playing out in a variety of ways within financial markets, including trading on the secured overnight financing rate known as SOFR.
The SOFR futures market is currently penciling in 113 basis points of rate cuts by the Federal Reserve in 2024 compared with 140 basis points that was expected before the Aug. 10 release of the July consumer price index report, according to Gennadiy Goldberg, head of U.S. rates strategy for TD Securities in New York. In addition, the pricing for the so-called trough rate — or level at which the Fed is likely to stop cutting rates — has shifted up from 3.3% four weeks ago to 3.8% today.
Source: Bloomberg, TD Securities
SOFR is the successor to the London interbank offered rate, known as LIBOR, which was the subject of a scandal a decade ago that involved allegations of collusion by traders. LIBOR was phased out to make way for SOFR, which traders use to telegraph their expectations for Fed policy.
The Fed’s main policy interest-rate target range currently sits between 5.25%-5.5% and is mostly expected to stay there when policy makers gather for their next meeting on Sept. 19-20. Fed Chairman Jerome Powell is scheduled to speak at the central bank’s annual symposium in Jackson Hole, Wyo., next Friday which should provide investors with further insights into his thinking.
See: Jackson Hole: Fed’s Powell could join rather than fight bond vigilantes as yields surge
Attention is moving away from questions about how much higher interest rates might go and toward how long it will be before Fed officials start to cut rates. As the thinking goes, the longer that the first Fed rate cut keeps getting pushed out into the future, the worse an environment that’s likely to be for stocks, analysts said.
“For markets, what really matters is the path itself — not just how far the Fed goes with rates, but how long it stays there before getting to the first cut,” TD’s Goldberg said via phone on Friday. “The longer the Fed leaves rates at restrictive levels, the more that weighs on the economy and pushes valuations lower.”
“We don’t think they’re going to deliver more rate hikes,” Goldberg said. “The Fed is concerned about long and variable lags and is quite cautious about delivering too much tightening. Policy makers’ discussion will be focused around whether they need to hike anymore, given that inflation is decelerating.”
During a week when investors have been rattled by a selloff in long-dated Treasurys— which sent 10- and 30-year yields to their highest closing levels since 2007 and 2011 on Thursday — the expectations of fed funds futures’ traders for the next few Fed meetings remained little changed. They still see a roughly 90% chance of no action by the Fed in September, little changed from a week ago, according to the CME FedWatch Tool.
Source: CME FedWatch Tool.
Meanwhile, fed funds futures traders also mostly expect no rate hike in either November or December despite a raft of recent data pointing to the continued resilience of the U.S. economy.
Lindsey Piegza and Lauren Henderson, economists at Chicago-based Stifel, Nicolaus & Co., have a different take. In a note on Friday, they said that a strong U.S. economy “will demand a stronger policy response to ensure a return to price stability — eventually — ensuring a downturn in activity.”
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