Rate cuts are "poisonous"? The Fed may be underestimating the market's tolerance

On the first trading day of Harris's presidential campaign, the US stock market surged, but the situation was not so optimistic the next day. While the market was trying to trade around the November election, there was another pressing issue - the market believed that there was a close to 95% chance of a rate cut by the Federal Reserve in September. Jim Bianco, President and Macro Strategist of Bianco Research, said that all of his positions are now neutral. He held 20% short-term inflation-hedged treasuries until the end of April, and has been reducing mortgage-backed securities until the end of May. The company's fixed income index can be tracked by the WisdomTree Bianco Total Return Fund (WTBN), which performed well in the second quarter among its peers. Bianco said that there are two ways to estimate the market's neutral federal funds rate (the rate that neither restricts nor stimulates the economy), and both calculations are significantly higher than the Fed's expectation of 2.75%. In other words, to reach the Fed's expected neutral rate level, it would require 10.5 cuts of 25 basis points, while the market expects that only 6.6 cuts of 25 basis points are needed to reach the neutral rate level. He pointed out that this difference can also be explained by observing the federal funds rate after deducting the core personal consumption expenditure price index (PCE) inflation - currently at 2.93%. "This is because the Fed is anchoring to the post-financial crisis period (after 2009), as shown in the red part of the chart below. During this period, the real rate averaged -1.08%. Therefore, the current rate of 2.93% must be a punitive level in their view. It is understandable that there are calls to start cutting rates early," he said. However, the post-financial crisis era is seen as abnormal by the market. Prior to this, the real rate averaged 2.55%, not much different from the current level of 2.93%. "The market is much more optimistic about the extent to which the current real rate restricts the economy," Bianco said, "the stock market continues to reach new highs, supporting this view." Currently, maintaining rate stability actually meets the market's needs more than the Fed's. Bianco said that the risk is that if the Fed starts cutting rates, it may cut too early and too much, which could lead to what he calls a "toxic reaction." "For example, we are now at the top of a roller coaster, everything will stop. But in the next journey, the roller coaster can move along one of several tracks. Therefore, we generally maintain a positive and relatively neutral attitude, seeking clarity on the roller coaster track to start the next thrilling journey."