Still Expecting More than 100 Basis Points Out of the Fed This Year (And Market Implications)

Let’s talk bonds and what the real driver has been and will continue to be. It’s ALL about the Fed’s reaction function.

At the near-5% cycle high for the 10-year T-note yield in October 2023, the markets and Fed were in sync for -50 basis points in rate cuts in 2024. The December dot plot was raised to -75 basis points of rate cuts for 2024, but the market went ahead and priced in -165 basis points of cuts and at that point the 10-year T-note yield plunged to 3.8%. When the Fed kyboshed that expectation in the opening months of 2024, when it stuck to its guns at three rate cuts worth -75 basis points for 2024, the bond market repriced to a 4.75% yield peak at the April highs because the futures market had gone from pricing in -165 basis points of 2024 rate cuts to just under -50 basis points! When push came to shove, the Fed eased -100 basis points, not the -50 that was priced in at the October 2023 yield peak, but also not the -165 basis points that was being discounted at the 3.8% yield trough in December 2023.

We are replaying the same story now for 2025. At the September 2024 yield low at 3.65%, we had nine cuts totaling -220 basis points of cuts being priced in to 2025. But the dot plots were for only 4 cuts and that is when the current problems for the Treasury market began. The Fed cut -100 basis points but stuck with its prior guidance. It goes to show how words matter more than deeds. That was the moment that the bond rally got snuffed out. Then the Fed went to two cuts for the 2025 dot plots at the December 18^th FOMC meeting from four, and at that point the markets were still discounting nearly four cuts with the 10-year T-note yield sitting at 4.4% heading into that FOMC meeting. But now the market is pricing in just -40 basis points of rate cuts for 2025 even though the Fed is currently at -50 basis points which is how we get to over 4.6% on the T-note yield.

I keep hearing about the “bond vigilantes” but in reality, there is no such thing as a “bond vigilante.” It’s about the Fed reaction function and there is no other variable as important as this in any bond yield model.

Now as for inflation, I am stunned that the bond market has had such difficulty since that +0.1% print we got on the core PCE deflator for November — that number came out on December 20^th and the 10-year T-note yield is up +10 basis points since that report. It can’t be caused by the stock market because from the nearby post-election peaks, the Dow Transports are down nearly -10%, the Russell 2000 is down -7%, and the S&P 500 equal weighted index is down -6%. And it’s not the data, which have been mixed at best — I realize the macro bulls went wild on Friday with the better-than-expected ISM manufacturing PMI print. Never mind that the grand total of 39% of industry members posted any growth at all to close out the year! The share of businesses in this survey saying they have growth has not crossed above 50% since August 2022. That’s a fact. The long-run average is 60%, and we are south of 40%.