The short-term Fed Funds Rate rose from zero percent in March 2022 to 5.375%, increasing financing costs for businesses and individuals. Over the past months, the hawkish monetary policy to battle inflation has stopped as the central bank paused short-term rate hikes when inflationary pressures subsided. Many market participants believe the Fed’s next move will be to cut rates, but inflation remains stubbornly above the central bank’s 2% target.
In my January 26 Barchart article on the bond market, I wrote:
Time will tell if the recovery in the U.S. bond market is over or if the rally has paused and we are in a consolidation period. Barring unforeseen events, the U.S. 2024 election, which will determine the path of U.S. domestic and foreign policy, will likely keep bond volatility low through November.
On January 26, the nearby March bond market futures were at the 119-14 level, with the May futures hovering around 120. On March 20, they were slightly lower at 118-28 on the day of the March FOMC meeting\.
The long bond futures recovered but remain in a bearish trend
Long bond futures have been trending lower since the March 2020 high.
The chart highlights, that the U.S. 30-year Treasury bond futures reached a high in March 2020 as the global pandemic gripped markets across all asset classes. U.S. bonds tend to be a haven of safety during tumultuous periods. Over the past four years, the long bond futures have made lower highs and lower lows in a bearish trend that reached the lowest since 2007 at 107-04 in October 2023. While the long bond future recovered and was near the 119 level on March 20, the bearish trend in the continuous futures contract remained intact.
The Fed refuses to alter its 2% inflation target
In 2012, then-Fed Chairman Bernanke set 2% as the central bank’s stated inflation target. Chair Yellen, who followed Chairman Bernanke, and Chairman Powell, who succeeded Chair Yellen, have stuck to the 2% inflation target like glue.
A late 2023 Time Magazine article pointed out two problems with the 2% target:
- The target rests on the assumption that people’s inflation expectations are critical to actual inflation. There is little empirical evidence that expectations impact the inflation readings.
- As Chairman Bernanke warned when he set the 2% target, the level’s arbitrary nature and need for flexibility could become “rigid and dogmatic” instead of addressing new and complicated economic scenarios.
While many market participants expect rate cuts before inflation reaches 2%, the Fed has stuck to its guns. However, the latest FOMC meeting and Chairman Powell’s comments hinted that the committee members could become more flexible based on continuing evidence that inflation is heading for the 2% level. The March FOMC meeting later today, on March 20, will likely continue to kick the rate cut can down the road after the latest round of inflation data.
The latest inflation data continues to show rising prices
On March 12, the February consumer price index rose 0.4% for the month and 3.2% from the previous year. While the monthly data was aligned with consensus forecasts, the 12-month data was slightly higher, continuing the trend over the past months.
Core CPI, excluding food and energy, rose 0.4% in February and was 3.8% higher on a year-on-year basis. Both readings were 0.10% higher than consensus expectations.
Meanwhile, a 2.3% increase in energy costs boosted the headline inflation reading. Food costs were flat from the previous month, while shelter costs increased another 0.4%. PPI and PEC data were also a bit hotter than expected. The bottom line is inflation remains above the elusive 2% target level, which will likely cause the Fed and its FOMC to keep rates steady at the next meeting.
The November election rhetoric is heating up
The 2024 U.S. Presidential Election is now a repeat of the 2020 contest, with incumbent president Biden facing former president Trump.
The economy is always a critical issue in national elections. While inflation has declined, it remains challenging. The highest interest rates in years have increased financing costs for businesses and individuals. The starkest example is that 30-year conventional mortgage rates have increased from below 3% in 2021 to over 7% in 2024, precluding many potential buyers from homeownership.
Expect increasing political pressure for the central bank to lower interest rates over the coming months, with both parties questioning the 2% inflation target. Meanwhile, as the Fed struggles to remain impartial as the election nears, the safest course will be to do nothing and wait until after the election to ease credit. This scenario will give the central bank more time and data to justify late 2024 and 2025 rate cuts.
Pressure for cutting rates will increase- Buy dips in the long bond futures or TLT ETF for three reasons
Political pressure to cut the short-term Fed Funds rate will increase as Democrats and Republicans jockey for position over the coming months. Meanwhile, the $34 trillion national debt and a 5.375% Fed Funds Rate means that debt servicing will increase the debt by over $1.8 trillion annually if receipts and expenditures are equal.
Market consensus expects rate cuts over the coming months, but continuing nagging inflation could disappoint market participants.
The three-month June long bond futures chart shows the overall bearish trend since late 2023. Short-term support is at the February 22 107-11 low. As inflation data remains higher than the 2% arbitrary target, Fed inaction could cause selling in the long bond futures over the coming weeks and months if inflation remains elevated.
The three-month chart of the iShares 20+ Year Treasury Bond ETF (TLT) shows the same pattern, with support at the February 21 low of $92.01.
I believe the Fed will eventually succumb to pressures to alter the 2% arbitrary inflation target and cut interest rates. However, higher-than-forecast inflation readings over the coming months could push bonds and the TLT lower, which could be a golden buying opportunity. I am a buyer of TLT and long bonds on dips and will take profits if rallies approach technical resistance levels of the four-year bearish trend at 134-14. If the Fed cuts rates over the coming months, before the election, all bets will be off as the bearish bond market trend will likely end. Until then, the bonds are a trading market, with the only factor that supports long-term investment the highest “risk-free” rates in years. On the other hand, traditional buyers from overseas hold less U.S. government debt because of the volatile geopolitical landscape.
On the date of publication, Andrew Hecht did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
