Who Needs Rate Cuts Anyway?

Financial markets entered this year with a head of steam, propelled by the belief that Fed rate cuts were coming soon — and often — in 2024. Reading between the lines of Fed Chair Powell’s remarks in December led credit markets to believe that five or six cuts of 25 bps to the Fed Funds Rate were on tap for the year beginning in March. No such scenario has materialized to date or will materialize in 2024, with most Fed watchers now expecting no more than two rate cuts, likely starting in September, as inflation has been sticky enough to give the Fed pause. “Higher for longer” already has become a tired slogan. Treasury rates have widened considerably this year, with the 10-year Treasury note yield moving 60 bps higher since year end, while the Secured Overnight Financing Rate (“SOFR”), the reference rate for most leveraged loans, has barely budged in months and hovers at 5.3%.1

Creeping anxiety and a growing chorus of cautionary comments from the economic and business punditry over huge federal budget deficits and soaring federal debt2 have been suggested as contributing factors to a recent weak Treasury auction and persistently high Treasury rates — which is the benchmark rate for corporate bond yields. None of these developments has stuck to the original script, but much like a Curb Your Enthusiasm episode, the players are improvising to save the scene.

As it turns out, financial markets have rallied fiercely to date even as interest rates remain lofty, and the Fed refuses to give markets the candy they crave. The S&P 500 has surged 11% to date following a blowout return of 24% in 2023,3 and all three U.S. major market indexes have touched record highs in 1H24 without an iota of help from the Fed. Moreover, the rally in the S&P 500 has occurred with virtually no change in 2024 consensus earnings expectations for the index in over a year, meaning the index’s appreciation consists entirely of an earnings multiple expansion — from 17x 2024 EPS just over a year ago to 22x 2024 EPS currently.? But it is not just equity markets that are determined to rally despite an uncooperative interest rate environment and persistent economic and geopolitical uncertainties. [...]

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