September 18, 2024: The Descent Is the Hardest Part

This week the Federal Reserve will almost certainly join other major central banks in easing monetary policy. It has been a long time coming. The Federal Funds target rate reached its peak of 5.25% – 5.50% last July. Having indicated last month that “the time has come for policy to adjust,” Fed Chair Jerome Powell has prepared markets for the initial decent.

As any seasoned mountaineer would tell you, a journey’s most perilous point occurs when coming down. For monetary policy and for investors, the risk begins with the size of the first step. Will the Federal Reserve cut its target rate by a customary 0.25% or make a larger cut of 0.50%? Economic data could support both decisions.

We do not know how large this week’s reduction in interest rates will be. What we know, however, is that markets have rallied over the last week in anticipation that this first step will be one of many. The 2-Year Treasury yield captures this anticipation succinctly; the spread between that rate and the Federal Funds effective rate is at its lowest level in over 15 years, a spread that reflects expectations that short-term interest rates will move sharply lower over the next two years. Last week’s rally in U.S. stocks reflects similar expectations—both in the path of interest rates and careful execution of their initial descent.

Weekly Market Update: September 18, 2024