Market's Underestimation of Fed Easing Could Signal a Bond Rally Ahead

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Market Overview Analysis by Michael Lebowitz covering: . Read Michael Lebowitz's latest article on Investing.com

Profitable bond trading opportunities arise when your expectations about Fed policy differ from those of the market. Therefore, with the Fed seemingly embarking on a series of interest rate cuts, it behooves us to appreciate how many interest rate cuts the Fed Funds futures market expects and over what period.

The graph below shows that expectations for the Fed Funds rate at the coming September 24th FOMC meeting have whipped around over the past year. Fed Funds futures currently imply that the Fed will cut rates by 34 bps at the September meeting. The table below quantifies the thirteen easing cycles shown above. Of these easing cycles, only two periods saw declines of less than 2.23%. 2.23% represents current market expectations. Of the two instances, the economy did not enter a recession .

Presuming the collective market thinks this time is different, they must believe that economic growth and inflation trends of the pre-pandemic have been reversed. If you think, as we do, that the last three years are an economic, fiscal, and monetary anomaly, then the opportunity to earn 4% or more on a longer-term bond is a gift.

At one point during each of those cycles, the market underestimated the amount of Fed rate cuts by roughly 2.50%While not pertinent to this article, the futures market also underestimates rate increases but to a much lesser extent.“If the Fed initiates rate cuts and if the data in the graphs prove prescient, current estimates for a Fed Funds rate of 1.50% to 1.75% in the spring of 2020 may be well above what we ultimately see.

 

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