By: Steve Sosnick Chief Strategist at Interactive Brokers

Markets were dealt a double whammy yesterday. First, we had the news about protests in China and concerns about how they could affect the production of key goods, like iPhones. Although overnight futures were pointing sharply lower, key indices were down only modestly throughout the morning. Then the Fed speakers returned, and markets certainly did not like their message. The bulk of yesterday’s 1.5% declines occurred after St. Louis Fed President Bullard and New York Fed President Williams gave independent addresses with a similar theme: don’t expect rate cuts until at least 2024.

The key points in Bullard’s commentary were: “we’ve got a ways to go to get restrictive,” and rates at minimum of 5%-5.25% would “have to stay there all during 2023 and into 2024”. A key quote in Williams’ talk was “I do think we’re going to need to keep restrictive policy in place for some time; I would expect that to continue through at least next year”. Some may wonder why two key members of the FOMC would specifically focus on rates in the second half of next year. A quick glance at the Fed Funds futures curve tells us why.

Fed Funds futures show rates peaking at about 5% in June. That certainly fits with Bullard’s narrative, though that is the low end of his stated rate expectation. Yet we see rates dropping almost immediately, with two 25bp cuts priced in by the end of 2023:

Fed Funds Rates Implied by Fed Funds Futures

(Click on image to enlarge)

Source: Bloomberg

Interestingly, the expectation for late-2023 rate cuts remains in place even after the Bullard and Williams comments. We can interpret this in two ways: either money markets believe that a recession that is sufficient to force the Fed to change its stance will occur by the end of next year, or the Fed will see the error of its ways and back off its restrictive stance on its own volition. The regional presidents want to take the latter idea off the table. That it remains a base case may be an ominous sign about pending recession fears.

In the short term, I see the FOMC’s motivation being a bit more benign. They’re simply sending a fresh version of the message that Chair Powell sent at Jackson Hole. A pivot is not coming, no matter how much we hope for one. This may be a bit more subtle, more along the lines of “peak rates do not mean that a pivot automatically follows”. Just as the FOMC wants to break inflationary expectations, it seems to me that they also want to break the market’s expectations that the Fed will always veer to accommodative policies as soon as possible. Or in more basic terms, they don’t seem to be eager to give a premature sign that it’s safe to jump back into the risk-asset pool. And by the way, their comments say nothing about reducing the pace and scope of balance sheet reduction. 

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