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Markets are on edge ahead of the Fed decision Wednesday and that includes bonds. The 10-year yield edging lower as bets on a 50 basis point cut keep rising. Joining us now is Guy LeBas, Janney Montgomery Scott Head of Fixed Income. So we were just talking about it, the big debate right now, 25 50. When it comes to the bond market, does it matter the size of Wednesday's cut?

Well, to some degree, right? Uh, you know, the uh the the action of what we're going to see on Wednesday afternoon is just one FOMC meeting. But depending on how it's framed, it also casts the next few meetings in its path as well. So, for sake of argument, right, we could see a federal reserve which comes out with a 25 basis point rate cut, but emphasizes the possibility, maybe even the probability that over time they could cut at a more accelerated pace. I don't think those are the exact words they would use. But were that to happen, right? We'd see, okay, this one rate cut done, perhaps on the hawkish side, but the future would end up pricing each additional FOMC meeting with a roughly 50/50 chance of 25 basis points or 50 basis points. And it would end up being a dovish 25 as opposed to a hawkish 50 in which there's a cut and a more gradual expected path.

You know, another question, we were just talking to our colleague Josh Schafer about this. The odds of 20 and 25 and 50 were pretty evenly balanced. And that now actually a shift to 50, why that shift, Guy? What changed? I know there were some high-profile press reports, but walk me through why you think that occurred?

Yeah, so I heard you talking about a couple of press reports on Friday from the journal and also the financial times, of course read those. I will say that in comparison to situations several years ago in which Fed officials were concertedly making a point to these publications, the language in the two press reports last Friday seemed a lot softer. It seemed a lot more, it could be this or it could be that. It didn't seem like language that in 2022 and 2023 when the Fed was prepping markets for supersized rate hikes that message that they were sending, that was a much more aggressive tone in the press reports. So I don't think there's really all that much there beyond preparing for that possibility. Now, one thing I think that is understated in this circumstance is that there's a certain momentum, uh, to short-term trading. And it only really requires a few basis points for a few large size trades to skew the odds of a 25 or a 50 basis point rate hike at a meeting in the very near term. So I think probably what you're seeing is more momentum rather than aggressive positioning ahead of a 50 or a 25 basis point cut for next Wednesday.

And you say the US is likely to have a very normal Fed rate cutting cycle. What's normal in your view? Because we've been operating in an environment that feels very not normal.

It's been so abnormal. Yeah. Yeah, I mean, look, the last rate cutting cycle was amidst the global pandemic. And, uh, you know, many of us were concerned about our own personal lives at that time for obvious reason. Uh, and the financial wheels were coming off the bus in real time. Uh, at that time, there were extreme extraordinary measures taking place. But there've been a long history, uh, dating back well prior to the global financial crisis of normal rate cut cycles in which the Federal Reserve after reaching some peak and inflation decelerating begins to lower rates. Uh, unfortunately, many of those cycles end in an economic downturn. I'm not convinced that's going to happen this time. There's certainly a chance, uh, but I'm not convinced it's going to happen. Uh, typically in mid-cycle corrections, the three that at least the Federal Reserve has successfully implemented in 95, in '97-'98, and again in 2019 have been a series of three rate cuts, each of them 25 basis points, and then a pause. Now, I think today we start in a circumstance in which we're much further away from neutral interest rates than in any of those periods. So more likely than three, we get four or five. But so long as economic growth holds up, if we get four or five 25 basis point rate cuts in the next two to three quarters, that's a pretty healthy situation. I think it frankly sets a leg the opportunity for a leg higher in risk assets like equities on the other side of that.

Just different questions we head into this meeting, um, Guy, I'm also curious what you make of the Fed's credibility here. It did get dinged. I'm wondering if you think there's kind of, there's been an improvement there. What grade you would give the Fed?

Well, I'm not a professor, so I don't grade them. But I will say that I think like academics talk about credibility very differently from sort of the, the, the financial media. So academics would talk about credibility as whether when the Fed says they're going to do something, do they do it? Does it affect markets? And is the result of that roughly what they expect? That's very different from the sort of popular perception of Fed credibility, which is are they right in their forecasts. And there have been numerous times in the last few years in which the Fed's primary forecast as distributed in the summary economic projections, the dot plots, was not right. Um, and that's going to be the case with any economic forecast for sure. But in terms of whether the Fed has control over the interest rate markets when they need it, uh, whether they follow through with the actions that they say they're going to take in a concrete way, they have absolute credibility in that sense.

And Guy, there's been a continuous expectation that the Fed is going to cut interest rates, which is part of the reason why we saw the yield curve uninvert. We talk about the yield curve all the time, you know, whether or not it indicates a recession or not. Since this easing cycle is expected to begin on Wednesday, what are your expectations for the yield curve moving forward? And how should we really look at and analyze those moves?

Yeah, so at the beginning of this year, or really the end of last year, in our 2024 outlook, we published a comment that haunts me a touch, I will say, that I had greater confidence that the yield curve would steepen towards the middle to end of 2024 than I did in the level of interest rates presented in those forecasts. Well, it took a long, long time, but we do look like we're in a little bit of a steepening trend here. Based on how far the front end of the yield curve, uh, call it the, you know, the two-year portion of the yield curve, has fallen, any more steepening from here realistically is going to require 10-year yields or the longer portion of the yield curve to rise. And that only really comes alongside a little bit of a reflationary impulse. I don't mean that in terms of inflation, but in terms of growth expectations. Uh, so we could get that in the form of greater productivity gains over time, uh, and essentially what's been popularly termed a soft landing or the avoidance of an economic downturn in 2025. And so I think that's really the next stage of yield curve steepening is about long rates moving somewhat higher from here.

We'll see what happens on Wednesday. Guy LeBas, thank you so much for your time.

Thank you, Alison.