Mid Week Bond Update

Fed Rate Cuts: Two More in 2019?

Global Thought Leadership
09 October, 2019
Even after the most recent cut by the FOMC, markets are pricing in another two rate reductions by the end of 2019.

The Fed: Two Cuts More?

The FOMC’s 25-basis-point (bps) rate cut on July 31, 2019 effectively reversed the 25-basis-point hike of December 2018, amending what some Fed critics viewed as a policy error. But how did the September 18, 2019 cut affect financial markets’ expectations for rate cuts in the rest of 2019?

The futures market for Fed Funds tells much of the story. Shortly before the September 2019 cut, futures traded as if the January 2020 Fed Funds rate would be about 50 bps below the Fed Funds effective rate at the time – 1.65% vs. 2.15%. That difference suggested the view that there would be either two 25-bps cuts or one 50-bps cut by the end of 2019.

Immediately after the September cut, however, that difference shrank by half – to about 25 bps (1.65% vs. 1.9%) suggesting a single 25-bps rate cut for the rest of the year. But later in September and into October, futures fell yet again, with the difference between the futures and the effective rate now widening from about 25 bps to nearly 38 bps by October 7, 2019. If that widening were to continue, it would suggest that another two 25-bps cuts would be in the cards – even after the September 18, 2019 cut.

Fed Funds Effective Rate vs. Fed Funds January Futures
Source: Bloomberg, as of 9/26/19. Past performance is no guarantee of future results.  Indexes are unmanaged, and not available for direct investment. Index returns do not include fees or sales charges. This information is provided for illustrative purposes only and does not reflect the performance of an actual investment.

There’s no shortage of explanations for the shift, including a change in the theoretical basis the Fed will use in setting its inflation and growth targets; the effect of public political pressure from the White House; or an as-yet-invisible impending economic slowdown.  

On the Rise: U.S. Job Leavers

Investors in U.S. credit were generally pleased with the September jobs report released on Friday October 4, 2019. In addition to the strong 3.5% unemployment rate, most of the report was generally upbeat.

One of the strongest statistics involved workers leaving their current jobs.  People who voluntarily quit and immediately start looking for other work reached 14.6% of the total number of unemployed workers, That’s close to the June 2019 high of 14.7%, a level last seen in October 2000, at the height of the Tech boom.

It’s important to remember, however, this figure is highly sensitive to the overall unemployment rate. The lower the unemployment rate, the higher the percentage of quitters will appear – even if the actual number of quitters remains the same. For example, in September 2019, there were 840k quitters; but the highest number of quitters, 1,097k, was reached in March 2012, when the unemployment rate was a much higher 8.2%. But even accounting for mathematical distortion, 840k workers willing to quit to seek better jobs is in no sense bad news.

On the Slide: Federal Reserve Balance Sheet

At the peak of the Fed’s quantitative easing program in January 2015, the Fed owned some $4.56 trillion in assets, the vast majority of which were U.S. Treasuries and mortgage-backed securities. As of October 4, 2019, the total had fallen to $.3.99 trillion, some $570 billion lower. In selling or letting $570 billion of bonds mature, an equivalent amount of cash was taken in, shrinking one component of the overall U.S. money supply.

But one component of the balance sheet grew in recent weeks – lending to financial institutions, which counts as an asset on the Fed’s books. As of October 4, 2019 that lending amounted to some 4.8% of the balance sheet, or about $190 billion. The reason for this increase is mostly due to the Fed’s supplying liquidity to financial markets to keep the Fed’s overnight rates within its own target range of 1.75% to 2%.

The Fed has stated that it’s seeking to find a longer-term solution to the need for a more liquid overnight market. Whatever solution is devised, it could very well add to the Fed’s balance sheet in the months and years ahead.


A basis point (bps) is one one-hundredth of one percentage point (1/100% or 0.01%).

The Fed Funds effective rate is the market’s rate for Fed Funds, usually strongly related to the Fed Funds target rate.

The federal funds rate (fed funds rate, fed funds target rate or intended federal funds rate) is a target interest rate that is set by the FOMC for implementing U.S. monetary policies. It is the interest rate that banks with excess reserves at a U.S. Federal Reserve district bank charge other banks that need overnight loans.

Fed funds futures are financial contracts that represent the market opinion of where the daily official federal funds rate will be at the time of the contract expiry. The futures contracts are traded on the Chicago Mercantile Exchange (CME) and are cash settled on the last business day of every month.

The U.S. Federal Reserve, or “Fed,” is responsible for the formulation of a policy designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

The Federal Open Market Committee (FOMC) is a policy-making body of the Federal Reserve System responsible for the formulation of a policy designed to promote economic growth, full employment, stable prices, and a sustainable pattern of international trade and payments.

Gross Domestic Product (“GDP”) is an economic statistic which measures the market value of all final goods and services produced within a country in a given period of time.

A Mortgage-Backed Security (MBS) is a type of asset-backed security that is secured by a mortgage or collection of mortgages.

Quantitative easing (QE) refers to a monetary policy implemented by a central bank in which it increases the excess reserves of the banking system through the direct purchase of debt securities.

U.S. Treasuries are direct debt obligations issued and backed by the "full faith and credit" of the U.S. government. The U.S. government guarantees the principal and interest payments on U.S. Treasuries when the securities are held to maturity. Unlike U.S. Treasury securities, debt securities issued by the federal agencies and instrumentalities and related investments may or may not be backed by the full faith and credit of the U.S. government. Even when the U.S. government guarantees principal and interest payments on securities, this guarantee does not apply to losses resulting from declines in the market value of these securities.

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