Federal Reserve Board member Michelle Bowman expressed concern about the current suitability of interest rates, suggesting that recent payroll revisions indicate a need for rate cuts. Despite inflation remaining above the 2% target, she argues that slow population growth and an ageing demographic will have long-term impacts on the neutral rate of interest.<\/p>\n
Bowman emphasised the importance of the Fed’s independence from political pressures. She advocates for a forward-looking approach to monetary policy, suggesting a shift from current data dependencies could better position the Fed in addressing future economic conditions.<\/p>\n
It is suggested that the Fed’s balance sheet should be smaller, with an emphasis on holding only Treasuries and shorter-dated securities for increased flexibility. The report underscores the potential benefits of a reduced level of reserves, possibly enhancing banks’ liquidity management.<\/p>\n
Additional points included the view that emergency lending facilities should remain for exceptional situations. Reforming the enhanced supplementary leverage ratio could address standing repo facility issues, while it’s noted that labour market risks currently outweigh job market concerns. Bowman observes the neutral interest rate is now higher than pre-pandemic levels, pegging it at a median estimate of 3%.<\/p>\n
We are seeing a significant shift from within the Federal Reserve, suggesting a pivot toward interest rate cuts is approaching. The argument is that the Fed is already “behind the curve,” a sentiment that will likely pressure the front end of the yield curve lower in the coming weeks. With the current Fed Funds Rate at 5.00%, derivatives markets will now begin pricing in a higher probability of a cut before the end of 2025.<\/p>\n
This view is strengthened by recent economic data, particularly the downward revisions to payrolls we saw in the last jobs report. The early September 2025 report revised the prior two months down by a combined 120,000 jobs, confirming a clear cooling trend that markets have suspected. We should expect the Fed to act proactively on this weakening labor market, rather than wait for lagging inflation indicators to hit their target.<\/p>\n
This creates a setup for yield curve steepener trades. While the prospect of rate cuts will anchor short-term rates, the push to actively sell mortgage-backed securities (MBS) will put upward pressure on longer-term yields. This dynamic, where monetary policy loosens via rate cuts but tightens via the balance sheet, is unusual and suggests trades that profit from a widening spread between 2-year and 10-year Treasury yields.<\/p>\n
The focus on long-term structural factors like an aging population means we should not be overly concerned that August’s Core PCE inflation was still at 2.8%. The Fed appears willing to tolerate inflation moderately above its 2% target to avoid triggering a sharp economic downturn. This is a playbook we saw used during other policy pivots, such as the shift from hikes to cuts back in 2019.<\/p>\n
This internal Fed debate between a gradual approach on rates and active management of the balance sheet introduces significant policy uncertainty. This environment is ripe for higher interest rate volatility. We should consider strategies that benefit from this, such as buying options on SOFR futures or bonds, as market sensitivity to incoming data like jobless claims and manufacturing surveys will be heightened.<\/p>\n
Therefore, our positioning should favor lower short-term interest rates while being wary of the long end of the curve. Options strategies that bet on a Fed cut are now more attractive, but the hawkish stance on the balance sheet means simply going long on all bonds is risky. We need to watch for signs of market stress, especially in mortgage markets, as any active MBS sales would be a significant change in policy.<\/p>\n
Create your live VT Markets account<\/a>\u00a0and\u00a0start trading<\/a>\u00a0now. <\/b><\/p>\n","protected":false},"excerpt":{"rendered":" Michelle Bowman advocates rate cuts, citing revised payrolls, demographic shifts, and a higher neutral interest rate.<\/p>\n","protected":false},"author":62,"featured_media":17023,"comment_status":"closed","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[59],"tags":[],"class_list":["post-31291","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-live-updates"],"acf":{"acf_article_selection_author":null},"aioseo_notices":[],"_links":{"self":[{"href":"https:\/\/www.vtmarkets.com\/en-ca\/wp-json\/wp\/v2\/posts\/31291","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/www.vtmarkets.com\/en-ca\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/www.vtmarkets.com\/en-ca\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/www.vtmarkets.com\/en-ca\/wp-json\/wp\/v2\/users\/62"}],"replies":[{"embeddable":true,"href":"https:\/\/www.vtmarkets.com\/en-ca\/wp-json\/wp\/v2\/comments?post=31291"}],"version-history":[{"count":0,"href":"https:\/\/www.vtmarkets.com\/en-ca\/wp-json\/wp\/v2\/posts\/31291\/revisions"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/www.vtmarkets.com\/en-ca\/wp-json\/wp\/v2\/media\/17023"}],"wp:attachment":[{"href":"https:\/\/www.vtmarkets.com\/en-ca\/wp-json\/wp\/v2\/media?parent=31291"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/www.vtmarkets.com\/en-ca\/wp-json\/wp\/v2\/categories?post=31291"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/www.vtmarkets.com\/en-ca\/wp-json\/wp\/v2\/tags?post=31291"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}