Fed Rate Cut Expectations Slashed

Below is a chart and brief excerpt from today’s Market Situation Report written by Tier 1 Alpha. If you’re interested in learning more about the Hedgeye-Tier 1 Alpha partnership, there’s more information here.

Today's bonus chart compares the Federal Funds Rate with the 2-year Treasury yield, which is seen as a proxy for market expectations of future Fed policy.

We entered the year with CME Fed Fund futures pricing in 7 rate cuts by December. Yes, 7! However, that expectation has shifted, with the current probability now down to only 32.4% for just 2 rate cuts. A month ago, the probability of only 2 cuts was 10.3%, indicating that the market was still heavily pricing in 3 or 4 rate cuts back then.

This vivid shift in market expectations highlights the dynamic nature of the inflation paradigm, which ProfPlum dove deep into during yesterday's Tier1 webcast. Our challenge lies in consistently questioning the quality of the data, calculating what inflation is and where it's headed, and then calibrating that to what the Fed perceives - which may be fundamentally different from the underlying economic reality. Then comes the task of reverse-engineering the Fed's reaction function, which may not necessarily align with what's best for the economy nor the reality of inflation at any given time. Only after that do we layer in determining whether the market has mispriced this reaction function, adding another dimension to the analysis.

We are indeed in a "higher for much longer" environment. We are living through a period of fiscal dominance. When you pre-stimulate an economy with $1.60 trillion in deficit spending, the resulting slowdown tends to look different and take on a different duration than it otherwise would, but we'll save that discussion for another day.

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