Monetary Policy, Election Uncertainty, and Economic Data — Evening Brief – 10.31.24 

The U.S. Treasury yield curve has witnessed a sharp rally in recent weeks in response to strong economic data, but also concerns about future fiscal policy decisions. The policy-sensitive 2-year yield, for example, traded as high as 4.21% on Thursday, its highest level since August 1, while the U.S. 10-year yield reached 4.33%, its highest level since early July.  

The rally has retraced approximately 50% of its 150-basis point swoon between April and September and has prompted the market to reassess its expectations of future monetary policy easing.  

Most analysts expect a quarter-point rate cut when the Federal Open Market Committe (FOMC) meets next Thursday, but some analysts believe a cut in December may now be off the table. 

A reason for cautious optimism for additional interest rate cuts in the near term is that the 2-year yield remains well below the current effective Fed funds rate range of 4.75%-5.00%. At the same time, Fed funds futures have barely shifted from their rate-cut expectation. As of Thursday, the market was still pricing in a 95% chance that the central bank would lower its target rate by a quarter point.   

“I expect the FOMC will cut the federal funds target by 25 basis points,” Bryan Jordan, chief strategist at Cycle Framework Insights, Inc., told Connect. “The data flow has undeniably improved since the last meeting in mid-September, but there have also been signs that the risks remain elevated,” citing the Fed’s most recent Beige Book.  

Jordan, however, also expects the FOMC statement and Powell’s press conference will be “less dovish” than the September meeting, “hinting at an unchanged policy stance at the December meeting” given improvements in job growth, consumer confidence, and consumption spending, and an uptick in long-term inflation expectations. 

“Longer-term, I expect that the easing cycle will resume in 2025, as the labor market continues to downshift and inflation continues to recede,” added Jordan.  

Tough Spot for Fed 

The FOMC must make a policy decision two days after the U.S. presidential election and will seek to avoid the spotlight by maintaining its anticipated 25 basis point cut, Palmer Square Capital managing director, Jeremy Goff, told Connect Money. 

“The 50-basis point cut was not supported by available data on the labor market, core inflation, and economic growth,” said Goff. “This kind of monetary easing is something the Fed’s only done in periods of market crises (2001, 2007 and 2020).” He anticipates Chair Jay Powell to be “very” neutral at next week’s meeting, likely reinforcing their “data-dependent reaction function.” 

In terms of election results, Goff belives if there is a “red wave” it would be bearish for US Treasury prices (bullish for yields) in both the near and medium term as the market would price in both stronger nominal growth, and significant deficit spending requiring more Treasury issuance. 

In that regard, escalating debt levels and perceived fiscal irresponsibility are resulting in increased volatility and a surge in yields, which may continue to exert pressure on bonds. The Treasury Borrowing Advisory Commitee stated on Wednesday that, “Lack of resolution of the debt limit runs the risk of undermining the foundation of the U.S. Treasury market,” and “these episodes can cause significant economic uncertainty, affect financial markets and impact U.S. credit ratings.” 

In terms of the stock market, Goff thinks it would likely be higher under a “red wave” scenario amid a “stronger growth outlook offsetting higher rates.” He expects to see weakness in import-dependent sectors and companies. 

Under a “blue wave”, Goff believes it will initially lead to a risk off enviornment “until they [Fed] get more clarity on which policies will continue, and which new ones will be implemented.” 

One thing is clear: whoever wins the election will have to cope with working under the constraints of the federal debt limit, which is scheduled to come back at the beginning of January at which point the U.S. will start draining the Treasury’s cash balance until another debt ceiling is approved.   

“The election is a wildcard, especially given the unusual amount of uncertainty associated with this particular contest, but it is a safe bet that any confidence boost in one half of the country will be offset by a confidence drop in the other half,” added Jordan.  

Data-Dependent 

The Fed’s next move was expected to be sorted out following this week’s bevy of economic releases, but thus far, the data has further muddled the waters. The U.S. Pending Home Sales Index increased 7.4% in September to 75.8, the highest level since March, compared to projections of 1.9% and 0.6% in August, according to The National Association of Realtors. 

Meanwhile, the ADP report revealed that U.S. private nonfarm payrolls rose sharply to 233,000 in October, higher than the 115,000 consensus and up from 159,000 in September, which was revised from 143,000. 

However, U.S. GDP rose 2.8% in the third quarter, down from 3.0% in the second quarter and shy of the +3.0% expectation, according to the initial estimate by the U.S. Department of Commerce. And the core PCE price index, the Federal Reserve’s preferred inflation gauge, increased 0.3% in September, matching economists’ consensus, but slightly higher than the 0.2% increase in August. 

“Even amid the better payroll and ADP numbers for September and October, there have been ongoing indications of a further easing in the trend of employment growth from here,” said Jordan. “Job openings, the average workweek, and temp payrolls are all still pointed lower.” 

The focus on Friday will be the September nonfarm payrolls report, with a median estimate of 140,000. The economics team at Jefferies believes the distortions from the two hurricanes, a strike, and rolling furloughs “make the report difficult to rely on.” The team does not think the Fed will be “motivated to change tack on policy based on the tone of the data.”  

“Similarly, the drag in October will likely be reversed in November, so we doubt we will have a clean look at the payroll data for the next few months,” the team added.