Interest rates took an unexpected turn a week after the FOMC cut rates for the first time this year. Since the conclusion of the meeting, the 2-year rate has jumped 7 bps, the 5-year is up 12 bps and the 10-year is up 10 bps. This is not what markets were expecting, despite most of the anticipated cuts being priced in already.
This week, FedSpeak made clear the differences between the hawkish and dovish camps of Fed members. Governors Stephen Miran and Michelle Bowman asserted that aggressive rate cuts are needed to protect the labor market. Conversely, hawks like Chicago Fed President Auston Goolsbee advocated for a cautious approach to avoid a spike in inflation, which could lead to a worse case stagflationary outcome. In response to a post-conference question, Fed Chair Jerome Powell commented, “We do look at overall financial conditions, and as we ask ourselves whether our policies are affecting financial conditions in a way that is what we’re trying to achieve...But you’re right, by many measures, for example, equity prices are fairly highly valued.” The last six words were enough to spook interest rate futures into expecting only one additional cut for the remainder of the year.
The U.S. government is facing another shutdown showdown next week as lawmakers return on Monday in hopes of passing another short-term spending bill by Tuesday to kick the can down the road again. With consistent intransigence on both sides leading up to next week, the question for many has moved from “will there be a shutdown?” to “how long will it last?” The Trump Administration has already started warning government agencies to begin preparing for furloughs and layoffs. Democrats view this as their only option to stop Trump’s legislative agenda as their votes are needed to pass any measure. More than anything, it sounds like just another big mess with both sides accusing the other of acting in bad faith and potentially putting the U.S. economy at risk.
Something to keep an eye on at month end will be usage of the various Fed funding facilities. The Fed’s Reverse Repo Facility (RRF) and its Standing Repo Facility (SRF) constitute a significant portion of the U.S. economic plumbing. Usage of both is trending in the wrong direction. The RRF - a facility for excess reserves - peaked at $2.7 trillion in December 2022 and has fallen as low as $10 billion in recent weeks. The SRF - a rarely used liquidity backstop - went from zero to $11 billion in June and could be as much as $50 billion by the end of September. A similar confluence occurred in September 2019, causing a spike in overnight rates, until the Fed printed more money and made the problem go away. We are in different circumstances now. Considering the Fed’s continuing balance sheet roll off and potential liquidity constraints, it could be different this time.
KEY INDICATORS THIS WEEK
Student loans - According to Transunion, 29% of student loan borrowers are in some phase of delinquency.
GDP - Q2 was upwardly revised from 3.3% to 3.8% due to increased consumer spending.
CORE PCE - Matched consensus estimates but remains elevated at 2.9%.
Next week - Jobs week!