The Federal Reserve has levitated interest rates enormously over the past year, and now some signs are emerging that the once-buoyant U.S. economy may be slowing. So investors are betting the Fed at last will pivot and reverse its hiking drive.
But that’s not likely to happen for some time, according to Jared Gross, head of institutional portfolio strategy at J.P. Morgan Asset Management. His evidence: The central bank has done zilch to suggest that it will.
“The Fed has said it’s not expecting to cut any time soon,” he said in a recent JPM podcast. “They have not given clarity on any potential pivot or the signal that will lead them to pivot. And yet the bond market does appear to be expecting a fairly rapid turnabout.”
Problems in the banking sector and other negative news—such as this week’s job-growth data—have fueled the notion that an economic downturn is coming. Hence, the thinking goes, rates must decline.
In recent weeks, the two-year Treasury, which tracks expectations for the Fed’s monetary policy, has plunged from its lofty level. The yield topped 5% in early March and since then has dropped to 3.8%.
What’s more, the futures market projects that, by year-end, the benchmark fed funds rate will be lower than today—in other words, that the Fed will indeed pivot. After a quarter-point boost at the Fed’s March policy meeting, the target range for the rate is 4.75% to 5.0%. Only 7% think it will be at the current range come December. Some 40% believe it will be at 4.0% to 4.25% by then, below the current level.
To Gross, investors are seriously misreading the Fed’s resolve and will end up getting more in line with a higher-for-longer monetary policy. He warned that “the market does appear to be getting offsides a little bit.” The result may be they “have to again sort of reprice expectations around Fed policy.”
So the “terminal rate,” the high point of the Fed’s tightening campaign, may stick around for a while, he commented. There might be “a longer duration at that terminal rate that is currently in the market,” he said.
In effect, the Fed has learned its lesson from the inflation surge that happened while it kept short-term rates near zero until early 2022, when the rate increases finally began, he observed. That dilatory approach harmed the Fed’s credibility, which had been strong ever since, under Paul Volcker, the body broke the back of inflation in the early 1980s, Gross said.
Fed officials, Gross said, “recognize that regaining their credibility requires them to put a thumb on the scale in favor of tighter policy, even if that sacrifices something with respect to employment, a potential recession and volatility in the financial markets.”