Powell Signals Rate Cuts Next Month, Sparking a Rally in Government Bonds (August 2024)

• Why Is the Fed Leaning Toward Rate Cuts Now?
• What’s Driving the Surge in Short-Term Bond Demand?
• How Are Upcoming Economic Reports Shaping the Fed’s Move?
• FAQs: Decoding the Fed’s Next Steps

Federal Reserve Chair Jerome Powell has set the stage for potential interest rate cuts as early as September, marking an end to the eight-month pause in monetary easing. This dovish shift sent Treasury bonds soaring, with the yield curve steepening to its widest gap in four years. While markets aren’t fully pricing in a cut just yet, futures suggest an 80% chance of a 25-basis-point reduction next month. The bond market’s reaction reflects growing concerns over a softening labor market and lingering inflation risks—particularly from potential Trump-era tariffs. With key employment and inflation reports still pending, traders remain cautious, keeping yields above August’s lows. Here’s why this Fed pivot has Wall Street buzzing.

Why Is the Fed Leaning Toward Rate Cuts Now?

Powell’s latest remarks highlight a delicate balancing act. On one hand, weakening job market data suggests the economy might need stimulus. On the other, stubborn inflation—potentially reignited by trade policies—could limit how far the Fed can go. "Powell is cementing market expectations for a September cut," notes Gregory Peters of PGIM Fixed Income. "The debate isn’t about if, but when—and how much." Short-term yields led Friday’s rally, with the 2-year Treasury dropping 10 basis points to 3.7%, nearing August’s lows. Swap traders now bet on two quarter-point cuts by year-end, though Natixis’ John Briggs warns pricing in more than that seems "overly aggressive."

What’s Driving the Surge in Short-Term Bond Demand?

Investors are flocking to shorter maturities, anticipating Fed easing will boost their returns faster than long-dated bonds. The 5-to-30-year yield spread just hit its widest since 2021—a classic "steepener" trade. "The front end now has Powell’s backing," says ING’s Padhraic Garvey, "but the long end remains skeptical about inflation risks." This divergence underscores a key dilemma: cutting rates while inflation lingers above target could backfire. Case in point? Late 2024, when long yields ROSE despite Fed cuts. Bank of America’s Meghan Swiber adds, "If the Fed eases prematurely, markets need clearer signals that inflation expectations aren’t becoming unanchored."

How Are Upcoming Economic Reports Shaping the Fed’s Move?

All eyes turn to the Fed’s preferred inflation gauge and this week’s 2-, 5-, and 7-year Treasury auctions. Strong data could delay cuts, while weak numbers might accelerate them. "There’s a long road until September 17," cautions State Street’s Michael Arone, noting upside surprises in growth or prices could trigger another bond sell-off. Political risks also loom—Trump’s attacks on Powell and threats to oust Fed Governor Lisa Cook (who vows to stay) risk unsettling markets further. One thing’s certain: volatility isn’t going away. As BTCC analysts observe, "The bond market’s tug-of-war between growth fears and inflation risks will keep traders on edge through 2024."

FAQs: Decoding the Fed’s Next Steps

How likely is a September rate cut?

Futures markets currently price in an 80% probability of a 25-basis-point cut in September, per TradingView data.

Why are short-term bonds outperforming?

They’re more sensitive to Fed policy shifts. Easing typically lifts prices for shorter maturities first, as seen in the 2-year yield’s 10-bps drop last Friday.

Could inflation derail the Fed’s plans?

Yes. The Core PCE index (the Fed’s preferred gauge) remains above target. Upside surprises might force policymakers to delay cuts, as happened briefly in 2023.