October hasn’t been accompanied by the type of stock selling we’ve witnessed the last two years, when U.S. markets fell sharply in October and reached a second-half-of-the-year bottom both times. Instead, this October has wrought a more subtle disappointment: rising interest rates.
Indeed, despite the fact that the Fed is cutting interest rates – starting with a 50-basis point cut to the federal funds rate in mid-September ringing in a new era of rate slashing – the 10-year Treasury yields have risen steadily since the calendar flipped to October, going from 3.80% to 4.24% – their highest level since July. In fact, Treasury yields are up 15% since September 18, the day the Fed cut rates for the first time in four and a half years.
Why is this happening? Why are interest rates (and, by relative proxy, mortgage rates, up a quarter-point in the last two weeks to reach 6.4% for a 30-year loan) doing the exact opposite of what the Fed intended? Because the economic data has improved, prompting many traders to scale back their expectations for exactly how fast the Fed will cut rates.
2 Reasons the Fed Is Cutting Rates
It started on October 4, when the September jobs report came in much better than the previous two months: 254,000 jobs added and the drop to a 4.1% unemployment rate. The 254,000 number obliterated economists’ expectation of a mere 140,000 jobs and was a far cry from the 159,000 added in August and 144,000 added in July – numbers that had sparked fears that the U.S. economy might be slipping toward a long-feared recession – and that the Fed had waited too long to cut rates.
The other development is that inflation continues to fall, with the September CPI (Consumer Price Index) number falling to 2.4% – its lowest reading since February 2021. That number was reported on October 10. The way-better-than-expected jobs number combined with inflation dipping to a three-and-a-half-year low have made for a sturdier, more settled economic environment. And that’s a good thing! But it might convince the Fed to go slower in what appeared to be a very aggressive rate-cutting program when it was initiated last month.
A month ago, CMEGroup’s trusty FedWatch Tool showed that a majority of industry experts – 53% of them – expected the Fed to slash rates by another 50 basis points, to a 4.25-4.50% range, in November. The remaining 47% expected the Fed to cut rates by just 25 basis points next month. Not one person thought the Fed wouldn’t cut rates at all next month.
Now, with U.S. economic data much improved in the last month, expectations are far more modest: 95% of traders think the Fed will cut rates by 25 basis points next month, 5% think there will be no cut. Not one person thinks there will be a 50-basis point cut, after a majority of the crowd thought that would be the case a month ago.
Taking it a step further, there is also now zero expectation that the Fed will cut interest rates by more than 50 basis points the rest of the year (including at their December meeting), down from 76.6% of traders thinking they’d cut by either 75 or 100 basis points a month ago. So, the expected pace of rate cuts has totally changed this month, and that’s due mostly to the recent evidence that the U.S. economy is more resilient than thought in September and August.
Short-Term Rate Uptick Won’t Last
Again, this is all good news. And in reality, it hasn’t done much to slow the market as a whole – all three major indexes are up in October and are hovering near all-time highs. But certain pockets of the market have felt the brunt of rising interest rates, and that includes homebuilder stocks, which are down 3.6% in the last month and have really taken on water in the last week as interest rates have spiked to three-month highs.
It won’t last. Whether they slash rates by 25 basis points or 100 in the next couple months, the fact is the Fed is cutting interest rates, and will be doing so for much, if not all, of 2025. And when the federal funds rate falls, so will interest rates and mortgage rates. Even if it takes a little longer than it seemed like it might a month ago.
With that in mind, I added a big-name homebuilder stock to my Cabot Value Investor portfolio last month. It’s off to a good start, despite some pullback in the last couple weeks. To learn its name, click here.
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