No. of Recommendations: 9
Since the Federal Reserve began raising the fed funds rate in 2022 to attempt to quell inflation the markets have been hoping for cuts to provide them with the crack cocaine of free money they enjoyed for most of the time since the 2008 financial crisis.
St. Louis Fed (FRED): Federal Funds Effective Rate (FEDFUNDS) | FREDThe markets have “front run” the Fed at least 4 or 5 times by anticipating cuts the the Fed didn’t do, followed by disappointment and a stock market drop.
All the speculators are jumping for joy that the Fed cut the fed funds rate by 0.25% last week as they predicted for months. Now they are front-running the Fed again.
wsj.com - Interest rates bets investors
Wall Street Bets Rates Will Drop Much More Than the Fed’s Forecasts
Futures markets show investors bet rates will fall below 3% by end of next year
By Sam Goldfarb, The Wall Street Journal, 9/21/2025
Wall Street thinks interest rates are poised to come down faster than the Federal Reserve does—a wager that is already boosting the economy and markets by making it cheaper for Americans to borrow.
Bets in the futures market show investors expect that the Fed’s benchmark short-term rate will fall just below 3% by the end of next year, from slightly above 4% now…
It is also below what most Fed officials are forecasting. Their latest “dot plot” showed a median expectation that rates end next year at 3.4%—the equivalent of two fewer quarter-point rate cuts than investors are anticipating. … [end quote]
The speculators are betting that President Trump’s pressure on the Fed will lead to a lower fed funds rate even if inflation stays high. They may be right.
Savers who like to keep significant liquidity (cash and short-term Treasuries) in banks and money markets will see interest income decline. We have already been through this twice since 2008. It's worth considering an extended bond ladder. If interest rates drop the value of the existing bonds will increase and they can be sold. It's normal for bond yields to fall during a recession which drives bond prices up at the same time that stock prices drop.
Barring QE from the Fed, the bond market sets the longer-term yields which control mortgage rates and other important economic interest rates. Investors in long bonds do not want to see their coupons eaten away by inflation. The lower fed funds rate can lead to higher inflation expectations and therefore higher long-term yields.
The Underlying Inflation Dashboard from the Atlanta Fed shows every data point in the red. Despite this, 10-Year Expected Inflation from the bond market is stable at 2.3%. This is calculated from a Cleveland Fed model that uses Treasury yields, inflation data, inflation swaps, and survey-based measures of inflation expectations and is independent of the BLS inflation numbers that I no longer trust completely since Trump fired the director of the BLS.
The Treasury yield curve is already beginning to steepen. The long bond yields began to fall in anticipation of the fed funds rate cut but now the yields are rising again at the long end. The 10-year Treasury, TIPS and real yields are now near the bottom of the channel they established in 2023 but they have not broken below their yield channel despite the expectation of a drop in the fed funds rate.
The yield curve will become steeper as it has many times before when the Fed cut the fed funds rate but the long yields remained high.
The Chicago Fed’s National Financial Conditions Index (NFCI), which provides a comprehensive weekly update on U.S. financial conditions in money markets, debt and equity markets, and the traditional and “shadow” banking systems, shows very loose financial conditions which is providing a flood of money. Financial stress is extremely low.
Debit Balances in Customers' Securities Margin Accounts, which broke $1 Trillion in June for the first time, continue to climb. This correlates with the climb in the stock indexes.
The trade is strongly risk-on as stock and junk bond prices are rising while the 10 year Treasury price is falling. The Fear & Greed Index is in Greed.
The weekly METAR is a short-term weather forecast. My longer-term concern is the bubble in the stock market which is underpinned by huge borrowing to build gigantic data processing facilities. Although much of the spending is by tech giants which can fund out of cash flow a lot is borrowed.
WendyBG writes on AI lending bubbleThe Price-to-earnings ratio based on average inflation-adjusted earnings from the previous 10 years, known as the Cyclically Adjusted P/E Ratio (CAPE Ratio), is 40 compared with a long-term median of 16. This is one of the biggest bubbles in U.S. history and would collapse if anything threatened investors' manic confidence in AI profits. Which so far are little to none. Even if the bubble doesn't collapse the market is tremendously overpriced so future returns will probably disappoint.
The METAR for next week is sunny.
Wendy
cmegroup.com - Cme fedwatch toolstockcharts.com: CandleGlance | StockCharts.comstockcharts.com: CandleGlance | StockCharts.comstockcharts.com: CandleGlance | StockCharts.comstockcharts.com: Dynamic Yield Curve | StockCharts.comcnn.com - Fear and greed St. Louis Fed (FRED): Market Yield on U.S. Treasury Securities at 10-Year Constant Maturity, Quoted on an Investment Basis (DGS10) | FREDSt. Louis Fed (FRED): Market Yield on U.S. Treasury Securities at 10-Year Constant Maturity, Quoted on an Investment Basis, Inflation-Indexed (DFII10) | FREDSt. Louis Fed (FRED): 10-Year Real Interest Rate (REAINTRATREARAT10Y) | FREDchicagofed.org - Current dataSt. Louis Fed (FRED): St. Louis Fed Financial Stress Index (STLFSI4) | FREDfinra.org - Margin statisticsatlantafed.org - Underlying inflation dashboardSt. Louis Fed (FRED): 10-Year Expected Inflation (EXPINF10YR) | FREDmultpl.com - Shiller peSt. Louis Fed (FRED): Real Gross Domestic Product (A191RL1Q225SBEA) | FRED 