Why the Fed won’t pivot to neutral any time soon

The market came into the year expecting Federal Reserve officials to shift to a less-dovish stance. Deutsche Bank came into the year saying that the Fed wouldn’t cut at all and many were expecting the more-hawkish FOMC members to at least float the idea of a long-lasting trip to the sidelines.

Instead, the message has been ‘more cuts are coming’. Fed Governor Chris Waller on Wednesday said he will support further cuts in 2025 and that inflation will continue to make progress towards 2%.

Why is he being stubborn when the market has clearly rejected rate cuts?

The answer: He’s not being stubborn, but practical.

While the Fed has cut rates 100 basis points since September, the market hasn’t cooperated. Since then, two-year yields are up 65 basis points and 30-year yields are up 100 basis points.

That’s not easing for the real economy, it’s tightening. Now we could certainly argue on the factors behind it and whether the Fed contributed it to it via policy mistake. I’d say it’s some combination of:

• The Fed cutting too aggressively
• The economy performing better than expected
• Election results leading to deficit worries
• Election results leading to tariff worries

There are people who really want to argue each of these factors, but from the Fed’s perspective, that doesn’t really matter now. The point is that conditions now are tighter than they were in September for the real economy.

The most-obvious lever for this is housing, which is highly rate-sensitive. The IYR real estate ETF is down 10% since the peak in September. While the home builder ETF is down 20%.

There is plenty of evidence that hot real estate markets are cooling, along with rents in those places. A similar dynamic has unfolded in other rate-sensitive sectors.

The pain will eventually filter through to businesses and consumers as well. It’s that looming that’s keeping the Fed cautious.With rates now near cycle peaks, they have every reason to expect that some pain is in the pipeline for the economy.

So while they’re taking some heat for what looks like a badly-timed set of rate cuts, what they actually delivered to the economy was tightness. They can see that in the bond market and, increasingly, so can equities.

Mixed in with all that are some real political uncertainties that are also keeping the Fed cautious. With all that, don’t expect a true pivot to neutral any time soon.

This article was written by Adam Button at www.forexlive.com.