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Falling bond yields help make another Fed rate hike likely next month, but expect a quick pivot to cuts in 2024, S&P Global says

Jerome Powell
Federal Reserve Board Chairman Jerome Powell.Drew Angerer/Getty Images
  • The Fed will hike rates by 25 basis points next month, S&P Global Ratings forecast.

  • That's as falling Treasury yields are no longer a constraint on financial conditions.

  • But the Fed will have to quickly pivot as the impact of high rates wears down on the labor market next year.

A final interest rate hike from the Federal Reserve is likely next month, as Treasury yields have become less effective in tightening financial conditions, S&P Global Ratings said in a Tuesday forecast.

While cooler inflation sparked bets that monetary policy could soon pivot to cuts, the ratings agency sees a 25-basis-point increase in December instead.

That's as Treasury yields have plunged, after last month's surge pushed long-dated rates above the 5% threshold. Those highs tightened financial conditions, allowing the Fed to keep rates steady at the 5.25%-5.50% range for two consecutive meetings, S&P said.

"Since then, financial conditions have eased somewhat (paradoxically increasing the chances of another rate hike), seemingly because of the following factors," it added.

The first was the Treasury's plan to issue more shorter-duration debt in the coming months, providing relief on 10-year yields. The second was the below-forecast October consumer price report, which prompted markets to rule out further rate hikes and pull forward rates cuts to earlier in 2024.

Meanwhile, expectations of an easing in core inflation pressures are somewhat exaggerated, mandating that the central remains hawkish, according to the note.

But once the Fed hikes, it will pivot quickly in June, when monthly payroll reports will turn negative and inflation gets closer to the target, S&P wrote.

Further cuts will come in the second half of the year, as the policy's impact on the labor market becomes more apparent. The agency expects rates to land at 4.6% and 2.9% by the end of 2024 and 2025, respectively.

"If downside risks to our baseline growth were to materialize, the Fed won't hesitate to cut more. If the economy keeps humming, the restrictive stance could last longer at its peak real rate," S&P said.

In its view, higher costs of capital will erode US hiring, and cause the unemployment rate to rise from 3.9% to 4.6% in 2025. Weaker economic growth will also pressure down labor demand.

S&P's outlook was supported by a speech from Fed Governor Michelle Bowman on Tuesday, who noted that elevated inflation could trigger more rate hikes.

Read the original article on Business Insider