For Jerome Powell, the chair of the Federal Reserve, the time is now. Instead of engaging in a monetary wonkery, he is focusing on the defense of the central bank’s credibility. The bond market has been bracing for Fed interest rate cuts to come, sometime next year. The question now is not whether Powell will continue making cuts but in what quantity and frequency.
The Federal Open Market Committee (FOMC) meets for the first time this year starting tonight. Analysts universally predict that it will announce a 25 basis point cut. What’s more, another similar cut is expected to be announced in December. The market has been expecting these cuts, which have already been priced into the stock market. It’s pricing in a full 100bp of easing in the next year — an indication of a profound turn in monetary policy.
U.S. interest rate cuts send waves through Europe. EUR rates specifically tend to move quite a bit in reaction to shifts in the U.S. yield curve. This transatlantic echo effect is important because it means that when the Fed makes moves, these moves are felt across American borders, filtering quickly through global financial conditions.
As Powell gets ready for this consequential meeting, experts warn that his statements aren’t telling the whole story. Rather, they contend that the true signals will be coming from repo market’s actions in the days after the meeting. Grasping these dynamics is important because they offer a window into how liquidity moves through the financial system.
The Fed meeting will have its most important takeaways, but that’s not going to come in the policy statement. Rather, they are buried deep within the implementation detail. If they see that there’s repo pressure still happening, traders on the front-end will jump on that immediately. They will eventually begin to price in bill purchasing, which will steepen the very short end. wondered a financial analyst who asked not to be quoted by name.
In recent weeks, intensity swap spreads have compressed. This change is due to a small fiscal miracle, propped up by tariffs that added another $120 billion in cash revenues. This influx has been instrumental in offsetting the deficit’s expansion, shifting the balance to provide a better starting point for any future fiscal policy.
Today’s yields tell a different story—cosmetic tweaks that have yet to be developed into meaningful, structural change. The 10-year yield remains near 4%. In the meantime, the 2-year yield remains anchored below 3.5%, producing a very flat yield curve. Against this backdrop, the possibility looms that these yields will find it harder to stay at these comparatively high levels as conditions on the macroeconomic landscape change.
Market participants view Powell’s impending shift from draining liquidity to circulating it as a strategic move aimed at stabilizing financial markets. This change should help to alleviate some of the pressures that have built in these repo markets. Those markets have faced increasing pressure of late.
It’s not an adrenaline trade — it’s a plumbing trade, opined another market specialist. This comment underscores the importance of maintaining smooth operations within financial systems rather than focusing solely on aggressive trading strategies.
One emerging trend that analysts have noted throughout these conversations is the focus on equity. When SOFR begins to increase and repo spreads narrow, this is the sign that “something’s clogging the drain.” This very unfortunate sentiment reflects deep-seated angst over liquidity and the financial system’s underlying condition.
Jerome Powell is preparing for a very different, battery-operated world. Realistically, everyone is concerned about how he conveys his intention and what signal will be given from the repo market post-FOMC. With big reductions in exchange rates down the pipeline, the local and global economies, as well as other markets, are destined to modify.