The Fed got the markets on board the easing train with a surprise 50 basis point cut at the start of the year, and continued chugging along at that speed over the next several months -- indeed, 50 basis point moves became the norm. And after a total of 250 basis points in rate cuts, many are looking for the Fed's locomotive to start decelerating and take a more cautious approach in navigating the twists and turns of the economy.
But, while some aspects of the May employment report released on June 1 suggested the FOMC might be able to switch over to the 25 basis point track, ongoing weakness in the National Association of Purchaing Managers' (NAPM) May index continued to signal warnings for the economy and left the market with enough uncertainty on the Fed to keep action in Treasuries choppy and volatile over the near term.
SPEED GAUGE. Traders will continue to scrutinize economic data over the next several weeks to get a better gauge on Fed policy. Will the data remain weak enough to keep the FOMC on the 50 basis point track, or will it stabilize sufficiently to switch the Fed to the 25 basis point track, or will it rebound sufficiently to bring the Fed to the end of the line?
Results of a survey of Fed watchers by Standard & Poor's MMS suggest the Fed train will slow to a 25 basis point speed as it approaches the rate-cut terminal. For the June 26-27 FOMC meeting, 91% of survey participants predict that Greenspan & Co. will lower the Fed funds target rate a quarter percent to 3.75% from current 4.0%. They say that with the stimulus already in the system, and with the tax rebates on board, the Fed can afford to move more cautiously.
However, many of those who expect less aggressive action also said it won't take much in the way of negative data to tip their forecast to a 50 basis point easing. Indeed, with the evaporation of the inflation threat, and with Europe showing increased contagion to the U.S. slowdown, there is little standing in the way of another 50 basis point cut.
Expectations for the August FOMC meeting are more of a toss-up, with 59% forecasting a 3.75% floor in the Fed funds rate, 36% going for another quarter point cut to 3.5%, and 5% predicting a 4% floor. A similar pattern emerges for the October FOMC, though one bear sees a 3.25% floor.
DATA WATCH. The market will have very little data with which to work over the coming week, given nothing of significance on the calendar. That will leave the bond market range-bound and increasingly subject to the whims of stocks and technical factors, rather than fundamentals. The rebound in the Dow on Friday, June 1, in the wake of the still-grim news on the economy suggests some upside potential at least early in the week. That could keep the short-end underperforming. But stocks will nevertheless remain vulnerable to the lackluster conditions in the economy.
Technically, Friday's sharp intraday reversal suggest further upside for the bond, while seasonal tendencies also point higher. Meanwhile, any sign of further erosion in the economy will heat up calls for aggressive Fed action and support additional gains in the short-end.
Farther out, key data on retail sales and industrial production will be available. MMS Survey results reflect the on-going data dichotomy, with the retail sales median showing a 0.3% gain total, and +0.4% ex-autos, while industrial production (-0.3%) and capacity utilization (78.1%) should paint a still bleak picture on manufacturing. Rupert is a market economist for Standard & Poor's Global Markets