Low Inflation And Softer Economic Growth Will Keep Fed On Pause

The odds are virtually nil that the Federal Reserve will raise interest rates through early 2020, according to Fed funds futures. Driving the market’s forecast: accumulating signs that the economy is slowing and inflation remains subdued. As long as this one-two punch remains is force, which seems likely based on recent data, the central bank’s recent run of policy tightening has likely ended and may even reverse course later in the year.

Meantime, the crowd is projecting that the Fed’s target interest rate will remain stable at the current 2.25%-to-2.50% range through January 2020, based on Fed fund futures via CME. Using this market as a guide, there’s a zero probability for a rate hike through early next year. In fact, the market’s projecting a small but slowly rising chance of a rate cut, edging up to a 26% probability by next January.

Yesterday’s update on the consumer price index (CPI) supports the no-rate-hike scenario. The core reading of inflation edged down to a 2.1% annual pace (in seasonally adjusted terms) through February, reflecting a rate that’s effectively holding at the Fed’s 2% inflation target.

 

The Treasury market’s implied forecast for inflation points to more of the same for the foreseeable future, based on the spread for nominal less inflation-indexed yields. The widely followed 5-year Treasury spread is currently at roughly 1.8%, suggesting that the market continues to price in expectations that the Fed’s 2% inflation target (or lower) will prevail for the near term.

 

Meantime, the near-flat Treasury yield curve continues to project relatively soft growth and tame inflation. For some maturities, the curve is inverted. For instance, a 1-year Treasury currently yields slightly more than a 5-year: 2.52% vs. 2.41%, based on daily data via Treasury.gov as of yesterday (March 12).

 

Profiling interest-rate momentum via a set of exponential moving averages suggests that rates will remain flat if not tick lower in the days and weeks ahead. The benchmark 10-year Treasury yield, for instance, continues to reflect a strong downside bias via this analysis.

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