An Update On Everyone's Predictions
On Thursday, I published a quick note that discussed the current monetary tightening expectations from the market via various Treasury spreads. One of the most accurate spreads to use, which we noted in Thursday's note, is the Fed Near Term Forward spread or more simply, the Treasury rate maturing in six quarters (1.5 years) minus the 3-month Treasury rate.
At the end of that note, I welcomed everyone to make a prediction of what 2019 would hold in terms of monetary tightening/easing and the results were wide-ranging. There were predictions for interest rate increases, interest rate cuts, various thoughts about quantitative tightening and nearly everything in between.
It will be a fun and educational exercise to continuously update the market expectation and continue a healthy discussion in the comments below.
Before updating some of the monetary tightening data, below are the two asset allocation tables that I provide each weekend for a three-dimensional look at cross-asset class performance.
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Now, on to the monetary tightening updates.
As mentioned, the Fed Near Term Forward spread is one of the best measures of what the market is expecting in terms of interest rate increases over the next four quarters.
In Thursday's post, the Fed Near Term Forward spread implied 16 basis points of monetary tightening over the next four quarters. Today, that has updated to 13 basis points, a small reduction.
Fed Near Term Forward Spread:
The following table shows the implied probability of an interest rate increase and an interest rate cut at each respective FOMC meeting. The date of the meeting can be seen on the left-hand side as well as the implied odds of a rate hike and a rate cut.
The table also shows the probability of the target range for the FF rate at each meeting based on Fed Funds futures. Currently, the target range for the Fed Funds rate is 2.25%-2.50% (highlighted in red). Through January 2020, the market is implying a 62.5% chance that the FF rate will remain in the same target range.
By January 2020, the odds of a rate cut are higher than a rate increase.
Bloomberg Implied Rate Hike Odds Based On FF Futures:
Another strong proxy for monetary tightening expectations is the 5-year Treasury rate minus the Federal Funds rate. In September, the 5-year Treasury rate was roughly 100 basis points higher than the FF rate as the market was expecting roughly four more interest rate increases. Today, the spread is down to 16 basis points after briefly inverting at the beginning of January.
The inversion of the 5-year Treasury rate and the FF rate is an extremely significant event and something we have been discussing at length at EPB Macro Research.
The only reason the market would drive the 5-year Treasury rate below the FF rate is if there is an explicit expectation of a rate cut in the near future. The market is telling the Federal Reserve that the short-term rate is too high.
5-Year Treasury Rate Minus FF Rate:
With more information, I'd be interested to hear updated thoughts in the comments below.
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I look forward to hearing your updated thoughts below!
I plan to update this data for followers of EPB Macro Research on a weekly basis.
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