The Federal Reserve kept its key interest rate at 5.25% to 5.5% at its July 31 meeting. During the press conference, Fed Chair Jerome Powell cited that progress had been made toward the Fed’s 2% inflation goal and said a rate cut in September is “on the table,” provided inflation data remained under control.
Following yesterday’s meeting, the 10-year Treasury yield fell below 4% for the first time since February on Thursday after a manufacturing gauge and jobless claims data added to evidence that the US labor market is cooling. The market move precedes Friday’s anticipated release of broader US employment data for July.
Sahm Rule Suggests Recession Risks are Increasing |
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| Source: Federal Reserve, TD Securities. As of 6/30/2024 |
Unemployment data is now close to triggering a recession indicator. If the employment rate rises to 4.2% in July from its June Level of 4.1%, it would trigger the “Sahm rule” which states that if the three-month moving average of the unemployment rate rises half a percentage point from its low point in the previous 12 months, then the economy is in a recession. During the press conference, Powell was asked about the “Sahm rule” and he stated that what “we’re seeing is a normalizing labor market,” though if “it starts to show signs that it’s more than that, then we’re well positioned to respond.”
US government bonds had their best month of the year in July, returning 2.2% as swap traders fully priced in three quarter- point cuts at each of the Fed’s remaining policy meetings, according to the CME Group. Fixed-income ETFs also took in a historic amount of cash as investors piled into the bond market, positioning for the start of a Fed rate-cutting cycle. Bond funds saw inflows of roughly $39 billion in July, the most on record.
Market pricing also reflects investors’ growing concern that the Fed might need to cut rates more quickly than the 25-basispoint quarterly cadence as economic headwinds continue to mount. However, while Powell mentioned that “we’re getting closer to the point at which it will be appropriate to begin to dial back restriction,” he also cautioned against assuming that a cut was definitely happening, stating “we’re not at the point yet. We want to see more good data.” He also seemed to rule out the likelihood of a 50 basis-point rate cut.
Rates have rallied over the last few days due to a combination of a more dovish Fed, moderating economic data, and geopolitical risks. If the employment data is weak tomorrow it could spur further momentum for the bull steepening trend. However, the Treasury market has indicators of crowded positioning based on expectations of a substantial easing cycle ahead of the July employment report. There are echoes from the start of the year when those who expected at least six quarter-point cuts were disappointed after inflation stopped slowing, prompting a violent rebound in yields that pushed the 10-year to around 4.75% in late April. Thus, any signs that the disinflation trend is waning, or stronger than expected employment data could spur a back-up in rates as bullish bets are trimmed.
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