Fed Minutes Analysis Continuation

Fed Minutes Analysis – Other Risks The Fed Mentioned: Inverted Yield Curve

I will continue my discussion in a previous article of the risks the Fed mentioned in its Minutes. The Fed mentioned the yield curve again, but ultimately since it is expected to raise rates in September, it doesn’t seem like it matters. It’s just lip service, meaning the Fed will invert the curve.

On Wednesday, the 10-year yield fell one basis point to 2.82% and the 2-year yield fell one basis point to 2.59%.

This means the difference in the curve is still 23 basis points. That’s very low.

There’s always the possibility that the curve can stay this way for a while, but with slowing growth and inflation, I expect the 10-year yield to stay below 3%. With 3 rate hikes coming in the next 12 months, I expect the 2-year yield to get close to 3%.

I expect an inversion to occur in the next 6 months. The inversion is up to the Fed, meaning the Fed isn’t a third party viewer like me. If the Fed were to announce it is stopping rate hikes after the one in September, then the curve would steepen.

Fed Minutes Analysis – Fed Funds Futures

The Fed is beholden to what the market expects, but it also affects the Fed funds futures market through guidance. The expectation for one 25 basis point rate hike in September went from 93.6% to 96% on Wednesday. This hike has been priced in for a while.

The real action is in the expectations market for a hike in December.

The chance of another hike in December stayed almost the same as it is at 62.8%. The threshold for a rate hike is usually 70%. Lately, there haven’t been many examples of actions the market wasn’t unanimous on.

I think there will be sharp action in the futures market up or down after the Fed makes its decision to hike rates in September and puts out its statement.

The Jackson Hole speech by Powell could also tell us what the Fed is thinking. In the Minutes, the Fed said Powell will be discussing the end of the balance sheet unwind this fall. I expect the Fed to give guidance about ending it in 2020 or 2021.