Cutting Rates without the Fed

The financial markets appear to be rather confident the Federal Reserve (Fed) will finally begin their rate cutting process at the September Federal Open Market Committee (FOMC) meeting, at a minimum. The debate has now shifted as to what this easing cycle will ultimately look like. In other words; a) could there be an inter-meeting move before next month’s convocation, b) if no inter-meeting move, will the September cut be 25 basis points (bp) or 50 points, c) will the policy-makers cut rates at each of the three remaining FOMC meetings for this year and d) what will the total amount of rate cuts amount to before calendar year 2025 gets ushered in.

Although rate cuts are now on the more immediate horizon, that is still a lot of uncertainty from a monetary policy standpoint. And, that’s not even considering what next year will have in store.

However, looking at the rally which just occurred in the U.S. Treasury (UST) market, one could be forgiven for thinking that rate cuts have already occurred. Indeed, while the lion’s share of attention is given to official Fed action, and rightfully so, yield movements in the UST arena can be arguably almost as important.

What do we mean by that? Well, let’s first take a look at what has transpired since late May, or only a little more than two short months ago. Obviously, one could probably even shorten the timeframe under review because a significant portion of the decline in Treasury yields occurred just over the last week or so.

Let’s start with the UST 2-year note, as this maturity will be more directly related to both the current Fed Funds Rate and expectations for the months ahead. From its late May level, the yield here dropped at one point by an incredible 132 bps, bringing the reading to an intra-day low of 3.65%. Of course, most of the headlines are reserved for the UST 10-year note. In this case, the yield plunged 94 bps for an intra-day posting of 3.67%. For the record, if you look at these two levels, you discover that the 2s/10s yield curve actually ‘un’inverted (a topic for a future publication).

So, what are the implications? Back to the premise of this piece: open market interest rates can serve as conduits for Fed rate action. While a variety of borrowing rates are pegged off Treasury yields, the one that really sticks out is mortgage rates. According to the Mortgage Bankes Association (MBA), the 30-year fixed mortgage rate dropped 27 bps to 6.55% for the week ending August 2nd (most recent available), the largest decline in two years. According to the MBA, this resulted in a surge in refinancing activity.

In other words, any tightening in financial conditions which was thought to have been spearheaded by the increase in Treasury yields earlier this year has now been reversed. To provide some perspective, the Chicago Fed National Financial Conditions Index has fallen to pre-Fed rate hike levels. The translation: financial conditions are very “loose.”

Even though Powell & Co. have yet to officially begin their rate cuts, the Treasury market has already done some of the work for them. In fact, the magnitude of the decline in UST yields since late May, and more recently, could very well be viewed as a rate cut of sorts.