Market and Fed’s Outlook Diverge

Jeffrey Roach (00:08):

Hi, I am Jeffrey Roach, Chief Economist for LPL Financial with some talking points for the current macro landscape. First market expectations diverge from the Fed's outlook. So while the Federal Reserve's latest plot signals only a modest pace of easing in 2026, markets are betting on a much steeper path of rate cuts. The September projections placed the federal funds rate near 3.4% by the year end of 2026. That's implying just one additional cut beyond 2025 levels. Futures markets, however, are pricing in multiple cuts reflecting expectations that slowing growth and a softer labor market will compel the Fed to act more aggressively. This divergence underscores a fundamental debate. Will inflation remain sticky or will disinflation and weaker demand dominate as markets seem to anticipate? The answer will shape the trajectory of monetary policy over the next two years. The wider the gap between the dot plot and market expectations, the greater the potential for volatility is traders recalibrate positions based on incoming data and fed communications.

Jeffrey Roach (01:15):

Second, it's more about Congress, less about Fed. A common question we get is where we think mortgage rates will head in the near term. We do expect mortgage rates to continue to come down from recent highs, but it's important to level set expectations here. A cut in the Fed funds rate does not necessarily mean mortgage rates will fall. The relationship between these two rates is complex. Mortgage rates are primarily influenced by long-term interest rate dynamics, which are shaped by the fiscal outlook and the 10-year U.S. Treasury yield rather than the Fed's short-term policy rate. That's why it's more important to think about Congress and what they're doing and less about the Fed and their policy. In 2024, even as the Fed began cutting the federal funds rate, mortgage rates remained elevated because treasury yields stayed high, amid concerns about persistent deficits and strong issuance, and this year was different.

Jeffrey Roach (02:13):

Mortgage rates fell in anticipation of a dovish tilt from the FOMC. This illustrates that while the Fed can influence short-term borrowing costs, mortgage rates are anchored to longer term expectations about inflation growth and government borrowing needs. Third, retail sales say minimal recession risks. August retail sales grew 0.6% from last month, and that's after posting an upwardly revised growth of 0.6% in July Q3 GDP growth could be stronger than expected. Discretionary restaurant spending suggests the consumer is on stable footing, minimizing recession risks. So after the recent release, I now expect Q3 GDP could approach 2%, if not higher, quarter on quarter. That's after the economy grew 3.3% in the previous quarter. Now further, it's important to note that historically risk assets perform well when the Fed starts cutting rates in non-res recessionary environments. Well, that's all for now. If you want more insights on global market trends, follow us on social media and take care.