Torsten Slok, Associate and Chief Economist of Apollolio, expressed reservations about the Fed's expected interest rate reduction in 2024.
The Wall Street economist warned investors before next week's Fed meeting not to be too excited about the prospect of a fall in interest rates next year.
Market perceptions of what the Fed might do in the months and even years ahead are often inaccurate and sometimes very different. While traders may have some idea of what the Fed might do at its next meeting, since then market perceptions have been mostly speculative.
In the latest notice shared with clients on Friday, Torsten Slok compared futures market pricing of changes in the Federal Reserve policy interest rate to changes in real federal fund interest rates.
Sometimes, the market has made the right judgement at least in the right direction, but in the past 15 years the expectations of traders have been far less achieved than the number of proven errors.
For example, investors were right to expect the Fed to start raising interest rates in 2014. At that time, Janet Yellen, the then President and current United States Treasury Secretary, had raised borrowing costs for the first time since the 2008 financial crisis. At first, however, investors expected the Fed's actions to be more radical than the eventual reality.
During the period 2009-2014, traders repeatedly saw their expectations for a rapid return to normal monetary policy dashed, as the Federal Reserve maintained interest rates at zero points longer than most expected.
Ultimately, the Fed decided to raise interest rates more slowly and cautiously than many traders expected. This text refers to the period during which traders expect the Fed to raise interest rates to normal levels more quickly, but in fact the Fed has acted more slowly and cautiously than they expected.
In the summer of 2019, when the Federal Reserve, led by Powell, began to lower interest rates for the first time since the financial crisis, traders again proved wrong. On this occasion, traders did not anticipate the rate of interest rate decline, despite the important role played by the COVID-19 pandemic.
Since March 2022, when the Fed began to raise interest rates again, the market has not been able to anticipate the rate and magnitude of the increase, and traders have been waiting for a “change” in the Fed’s policy, but have been repeatedly disappointed.
Torsten Slok indicated that, after a reduction in interest rates is expected to start around the middle of next year, traders may again be disappointed, given the Fed ' s insistence that it plans to maintain higher interest rates over a longer period of time to moderate inflation.
While traders are once again betting on the Fed’s turn, the Central Bank’s most recent interest-point forecast line summary shows that senior officials expect to maintain policy interest rates above 5 per cent by 2025.
Torsten Slok states: “When interest rates are lower, the market will systematically price the Fed's interest rate will soon rise. When interest rates are high, the next step for the Fed to be systematically priced is to lower interest rates.
Torsten Slok added: “Maybe the Fed will drop interest rates next summer, perhaps not. At present, investors should be prepared to face higher interest rates over the long term.”
The Fed will announce after its two-day policy meeting in November (i.e. on 1 November) whether interest rates will be raised or maintained. According to the Fed Watch tool, Federal Fund futures traders generally expect the Fed to maintain interest rates as high as 99.5 per cent next week.