The Fed cuts rates again … only two cuts forecasted for next year … sideways inflation is the issue … stocks tank … keep your eye on the 10-year Treasury yield
Today, the Federal Reserve cut interest rates by 25 basis points in a split vote where one Fed president voted to hold rates steady. The new fed funds target rate is 4.25% – 4.50%.
While this cut was expected, what was unexpected – and roiled the markets – was the new forecast for rate cuts next year.
The consensus among Fed officials is now for only two rate cuts in 2025. That’s down from the September forecast of four cuts.
Behind this reduced forecast is an upward estimation of inflation. Back in September, the median Fed official saw inflation at 2.1% at the end of 2025. Today, that median figure jumped to 2.5%.
In his press conference, Federal Reserve Chairman Jerome Powell said that the Fed is “on track to continue to cut.” But he noted that officials would need to see more progress on inflation before enacting those cuts:
As we think about further cuts, we’re going to be looking for progress on inflation… We have been moving sideways on 12-month inflation.
As for the economy, Powell was overwhelmingly optimistic, saying, “I think it’s pretty clear we have avoided a recession,” and “we think the economy is in a really good place.”
However, Wall Street wasn’t interested in Powell’s economic optimism. Its takeaway from today was “fewer rate cuts in 2025 means less spiking of the punchbowl for stocks.”
The Dow collapsed 1,100+ points while marking its first 10-day losing streak since 1974… the S&P fell 3%… and the Nasdaq lost 3.6%.
Meanwhile, the 10-year Treasury yield has jumped to 4.51% as I write, which is the first time it’s been above 4.5% since last May.
Wall Street, we have a problem…
Where does the 10-year yield go from here, and what will it mean for stocks?
For newer Digest readers, the 10-year Treasury yield is the single most important number for the global economy and investment markets.
Interest rates and asset values worldwide are directly impacted by whether the 10-year Treasury yield rises or falls.
The higher it climbs, the more pressure it puts on most stock prices because a higher yield means a higher discount rate, which lowers the current valuation of a stock.
As I’ll show you in a moment, the 10-year yield has been climbing since the Fed began cutting rates in September. And in the wake of the Fed’s decision, it’s roared higher. If it doesn’t cool off, this is going to be a big problem for your portfolio.
Since the Fed began this rate-cutting cycle back in September, the 10-year Treasury yield’s behavior has bucked expectations
Usually, lower interest rates would result in lower treasury yields. Instead, the 10-year Treasury yield has exploded from about 3.71% to 4.51% since the first rate cut September 18th.
This is quite abnormal.
Below is a chart from Steno Research that we featured in the Digest in late-October. The chart shows how the 10-year Treasury yield has behaved in the wake of past Fed rate cuts compared to how it’s behaving today.
The black line is the median move in the 10-year yield. The shaded gray area covers the 20th through 80th percentiles of moves.
The blue line (circled in red) shows what happened between the September cut and the ensuing several weeks. It had never occurred before.
The situation has only grown more abnormal since.
The 10-year Treasury yield continued climbing from roughly 4.19% when this chart was published to its yield as I write of 4.51%.
By the way, this yield was at just 4.38% this morning before the FOMC decision and Powell’s press conference.
Now, why has it been climbing despite rate cuts?
Because the bond market is paying more attention to growth/inflation/spending forecasts than the Fed
The bond market has been reacting so unusually to rate cuts because it doesn’t believe that inflation and government spending will play nice with the Fed’s rate-cutting plan.
For perspective, rewind to September…
Traders were all but certain that by January, the Fed would have lowered its target rate to at-or-below 3.75% – 4.00%. Specifically, that probability was 88.6% – a near lock.
Today, that probability is 0%.
Not only that but the odds that the Fed will lower rates to 4.00% – 4.25% by January are also now 0%.
I have to note that the degree to which futures traders have been wrong about the Fed – for well over a year at this point – has been truly breathtaking.
Now, as I just noted, behind this massive recalibration is growing fear of reinflation and deficit spending (meaning more debt issuance).
Here’s Barron’s from yesterday:
Bond investors have been ditching longer-term Treasuries since the Federal Reserve started cutting interest rates in September…
Some economists believe lower borrowing costs, coupled with Trump’s plans to cut taxes and raise levies on imports, will trigger a flare-up in inflation, which could add to the selloff.
The Treasury Department is also expected to auction off more bonds as the deficit carries on rising—and higher supply typically leads to higher yields.
The Barron’s article quotes T. Rowe Price’s CIO of fixed income, Arif Husain, who believes the 10-year yield at 5%+ or even 6% is possible in 2025:
The new U.S. administration represents meaningful new information, and at a minimum, it creates uncertainty and a broader set of outcomes. Is a 6% 10-year Treasury yield possible? Why not?
And yet the Fed cut rates again today.
The bull case is that this inflation uptick won’t last, so the 10-year Treasury will be falling soon
Let’s go to our hypergrowth expert Luke Lango for more:
The big-picture reality here is that the stock market rally has been stalled by reinflation fears, but recent data does not support those reinflation fears…
Going into Wednesday’s Fed announcement, the market is pricing in 99% odds of a rate-cut and two additional rate cuts in 2025, for a grand-total of three rate cuts between now and the end of next year…
That implies huge downside risk for Treasury yields. That’s because, in previous “soft landing” situations like 1995/96, 1998, and 2019, the 10-Year Treasury yield tended to fall to around the Fed Funds rate.
If the Fed does cut three more times into late 2025, that would bring the Fed Funds rate down from [4.50%] today to 3.75% over the next 12 months.
Therefore, according to historical precedents, the 10-Year Treasury yield could fall from [4.50%] to 3.75% over the next 12 months if the Fed does cut rates three more times. If yields do plunge in that manner, stocks should rally. We like that set-up.
We hope Luke is right.
“Jeff, a rising 10-year yield doesn’t matter as much as you suggest – it’s climbed since September, but stocks have jumped higher at the same time”
Ignoring what’s happening today, I’ll respond with “that’s true, but with an asterisk.”
First, stocks have, in fact, climbed since September. But they climbed based on “ride off into the sunset” forecasts for inflation and interest rate cuts in 2025.
However, those projections have stumbled over the last month and created a “tale of two markets” for stocks.
Earlier today, before the Fed announcement, the S&P 500 was less than 1% below its all-time high.
Or was it?
Since late-November, we’ve returned to a market dynamic in which the S&P appears to be climbing higher, but that outperformance is largely thanks to a handful of massive tech stocks (think the Mag 7) that are firing on all cylinders. Meanwhile, beneath the surface, the average S&P stock has been falling.
Below is how this looks…
We’re comparing the S&P 500 compared with the S&P 500 “Equal Weight” index. As the name suggests, this gives equal representation to each stock in the S&P instead of giving the biggest stocks heavier allocations.
The chart shows the last three months. The S&P is in black while the S&P Equal Weight is in red.
As you’ll see, they traded in tandem until just after Thanksgiving when the S&P Equal Weight Index dropped 4% while the S&P 500 Index traded sideways.
Of course, in the wake of today’s FOMC meeting, they’ve both plummeted…
So, will the average stock get its mojo back and join the mega-cap tech leaders?
Well, it depends – will the 10-year Treasury yield get its mojo back and relax a little bit?
If not, this bull faces some major headwinds.
If all this leaves you unsure about the best way to invest today, Luke, along with Eric Fry and Louis Navellier have a suggestion…
AI.
Yes, the market is overvalued, and the bull case rides on a handful of assumptions that aren’t guaranteed.
But one way to sidestep those risks is by investing in a handful of AI leaders that are likely to see enormous growth next year as AI hits “Phase II.”
According to Luke, Eric, and Louis, the AI Revolution is about to enter a new phase, and a different set of companies will lead the way. Yesterday’s “Magnificent 7” are about to become the “AI Eight” then Nine…then Ten… and Twenty…
You see, we’ve experienced the AI enabler boom. This was when AI infrastructure leaders like Nvidia and leading semiconductor plays saw enormous capital inflows and soaring stock prices.
But now comes the “AI appliers.” These are the companies that don’t “enable” AI, but rather, “utilize” AI within their own products and services.
These companies are everywhere and growing daily.
Luke, Eric, and Louis just released their new AI Appliers Portfolio during a special broadcast. It consists of the “best of the best” of this next generation of AI stocks – ones that have skyrocket potential as AI’s reach broadens in 2025.
Circling back to today’s Fed announcement – another cut is in the books.
Let’s cross fingers that this doesn’t come back to haunt us in a few months.
Have a good evening,
Jeff Remsburg
