The Fed's Tightrope Walk: Navigating Rate Cuts, Funding Strains, and a Murky Economic Outlook
Last week, the Federal Reserve took a predictable step, cutting interest rates by 0.25% and officially ending its quantitative tightening (QT) program, effective December 1st. But here's where it gets interesting: despite this move, the future of monetary policy remains shrouded in uncertainty, leaving markets and analysts alike scratching their heads.
Key Takeaways:
December Cut Still on the Table? While Fed Chair Jerome Powell downplayed the likelihood of a third consecutive rate cut in December, calling it “far from” certain, we believe it remains a strong possibility. Powell's cautious tone, coupled with dissenting votes from FOMC members (one advocating for no cut, another for a larger 0.50% reduction), highlights the committee's internal debate.
See AlsoOpenAI's $38 Billion Deal: Powering AI with Nvidia Chips and AWSPfizer's Legal Bid to Block Novo's Metsera Acquisition FailsHow AI and Geopolitics Are Transforming the Earth Observation Market in 2025AI Stocks Rally: November Kickoff, Palantir Earnings, & Starbucks China Deal | Stock Market UpdateFunding Markets Under Pressure: The end of QT and the shift towards reinvesting in Treasury bills aim to address mounting pressures in funding markets. Rates in these markets are climbing above the Fed's target range, as evidenced by the recent surge in overnight SOFR (Secured Overnight Financing Rate) to 4.22%, a significant 35 basis points above the effective federal funds rate. This tightening liquidity, exacerbated by increased Treasury bill issuance and declining reserves, could prompt the Fed to consider temporary open market operations (TOMOs) if conditions worsen.
Inflation vs. Employment: A Delicate Balance: The Fed's dual mandate of price stability and maximum employment is being tested. While inflation remains above target, the labor market shows signs of weakening. Powell acknowledges the challenge: “there is no risk-free path for policy as we navigate this tension.” We anticipate the Fed will prioritize supporting employment, leading to another rate cut on December 10th, despite inflation concerns.
And this is the part most people miss... The Fed's decision-making is further complicated by the lack of economic data due to the government shutdown. This data vacuum adds another layer of uncertainty to an already complex situation.
Exhibit Analysis:
Exhibit 1: The probability of a December rate cut has plummeted from nearly 100% before the meeting to around 68% today, reflecting the market's uncertainty.
Exhibit 2: The implied rate curve has shifted upwards, indicating expectations for a less aggressive easing path into 2026 compared to pre-meeting forecasts.
Exhibit 3: Repo market strains persist, with rates remaining elevated, highlighting ongoing funding pressures.
Exhibit 4: The Fed's standing repo facility (SRF) is seeing increased usage, suggesting counterparties are increasingly relying on this tool to access liquidity despite its perceived stigma.
Controversial Question: Is the Fed Doing Enough to Address Funding Strains?
While the Fed's actions aim to alleviate funding pressures, some argue that more aggressive measures, such as TOMOs, are needed to prevent a liquidity crunch. What do you think? Are the Fed's current actions sufficient, or should they be doing more? Let us know in the comments below.
