The Fed’s Long, Strange Trip

At DataTrek we love a good time series analysis, so let’s look at Fed Funds over the last 60 years and consider what a long, strange trip it’s been:

  • March 1959: 2.80%
  • March 1969: 6.79%
  • March 1979: 10.09%
  • March 1989: 9.85%
  • March 1999: 4.81%
  • March 2009: 0.18%
  • March 2019: 2.41% (i.e. basically right back where they started)

That round trip tells you everything you need to know about Federal Reserve monetary policy over the last 6 decades:

  • One massive inflation spike in the 1970s/early 1980s …
  • … Central bank intervention to calm it …
  • … And declining rates ever since …
  • … Culminating in zero rates to respond to the Financial Crisis …
  • … And a slow grind back to levels that President Eisenhower would have recognized.

So where do Fed Funds Futures say the Fed will set policy for the remainder of the year and into 2020? The answer:

  • Don’t expect the central bank to do anything at the May, June or July meetings. The odds that Fed Funds stay at 2.25% – 2.50% are +85% for each contract.
  • The odds that the Fed Funds will be lower than today increase in September (25%), October (31%) and December (43%).
  • By the first FOMC meeting of 2020 (January), Fed Funds Futures give 50/50 odds that Fed Funds will be lower than today or the same.
  • There is no probability of a rate increase baked into any Fed Funds Futures contract through 1/2020.

What this means for equity investors:

  • The Fed’s about-face on rate policy back in early January ignited a rally that continues to this day.
  • Importantly, this shift in policy also reset expectations for long-term rates and the 10-year Treasury now sits with a much more equity-friendly 2.5% yield in contrast to the +3.0% coupon that spooked markets back in October 2018.

The bottom line is that the best-case scenario for US stocks is an odd amalgam of continued growth (giving a boost to earnings) but weak inflation (which gives the Fed reason to cut rates and leaves the 10-year quiescent). It is a very specific recipe, to be sure, but one that incoming economic data will have to follow in order to keep equity markets on track.

Source:

Fed Funds: https://fred.stlouisfed.org/series/FEDFUNDS

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