Over the past two months we have seen financial markets vacillate between the Federal Reserve not cutting rates this month, to cutting only a quarter of a percentage point to going half a point. Today, the Fed went with option 3, lowering its overnight target rate to 5% from 5.5%. This was not a consensus call in the market and only last week, most economists were predicting a more modest move. Based on the language in the accompanying policy statement and Chair Powell’s remarks, this is just the start of a series of rate cuts. The question is whether there are more half-point reductions to come or was just a one-off.

 

In the statement, the Fed indicates that its confidence has growth that U.S. inflation is moving towards its 2% target. Moreover, it now believes that the risks associated with meeting its dual inflation and employment mandates are pretty much in balance. This is an interesting point, since inflation is not yet at 2% and core inflation remains sticky; however, recent labour market developments suggest that a trend of rising unemployment rates could steepen. 

 

The chart above shows the Fed funds rate target and the national unemployment rate. At 4.2%, the unemployment rate is on par with where it was in late-2017 and at that time, the Fed’s target rate was 1.25%. The Fed tightened to a peak rate of 2.5%, but that is still half of where the target is today. The Fed’s own forecast shows the unemployment rising to only 4.4%, which is only a percent above its recent low.  Such a mild rise in the rate would be pretty uncommon, but not impossible.  It is certainly not impossible if the Fed proceeds to lower rates on a steady basis into 2025 and the so-called dot plot shows that consensus of Fed officials is that rates get down to the 3% level.  This is where Ally and I have suggesting would be the floor by the end of next year, but there is a tremendous amount of uncertainty around that forecast. Looked at past episodes where the Fed cut rates may not be helpful either.

 

The chart above shows the path that the Fed funds target has taken in previous cycles, both the magnitude of the cumulative easing and the duration of the cycle. In 1984 and 2019, we saw very brief and small adjustments to the target, while the early 2000s and late 1980s saw significant easing over more than two years. I would suspect that this cycle is going to be shorter and smaller than those two experiences.

 

Today’s decision sent the 2yr U.S. treasury yield from 3.66% this morning to as low as 3.54% during Powell’s press conference. This shrinks the gap between U.S. and Canadian yields and provided a small lift for the Loonie. The message for investors is exactly what we have been saying for months. Even if there is a debate over when rates fall and by how much, there is no “if” in this analysis. This means that reinvestment risk is here, meaning that rolling over short-term or money market investments is going to see lower returns going forward.

 

On behalf of the Pyle Wealth Advisory team, have a wonderful rest of the week.   

 

Andrew Pyle

 

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The CIBC logo and “CIBC Private Wealth” are trademarks of CIBC, used under license. “Wood Gundy” is a registered trademark of CIBC World Markets Inc Andrew Pyle is an Investment Advisor with CIBC Wood Gundy in Peterborough. The views of Andrew Pyle do not necessarily reflect those of CIBC World Markets Inc.