Federal Reserve Governor Christopher Waller stated that after the rate cut in July, any policy changes should be based on new data and considered during each meeting. He mentioned that a long-term Fed funds rate might be around 3%, although he acknowledged some uncertainty in this figure. He pointed out that current long-term bond yields do not suggest very loose financial conditions.

Fed’s Balance Sheet Strategy

Waller discussed the Fed’s balance sheet, saying there’s no rush to sell the mortgage bonds owned by the Fed. He described this as a slow process and noted little eagerness for aggressive sales. He stressed that market signals should guide how much to reduce the balance sheet, instead of focusing on fixed goals. He also talked about stablecoins, viewing them as a way to boost competition in the payment system without causing major risks. On future roles, he confirmed he hadn’t been contacted by Donald Trump about becoming Fed chair. He mentioned that differing opinions among Fed officials are helpful and highlighted everyone’s commitment to keeping the central bank independent. Given his comments, a rate cut in July seems very likely. Market data shows a more than 90% chance of a 25-basis-point cut, according to the CME FedWatch Tool from mid-July. This expected move is already reflected in interest rate futures for the front month. His focus on upcoming data for future decisions adds a lot of uncertainty for policies later this year. Although June’s Consumer Price Index fell to 3.0% year-over-year, the job market remains strong, with 272,000 jobs added in the latest report. This creates a complicated picture for inflation. We believe that options betting on volatility for the September and December meetings, which seem currently undervalued, look attractive.

Market Volatility Index

The recent drop in the MOVE index, which measures bond market volatility, to nearly two-year lows seems at odds with the meeting-by-meeting approach stated by officials. This indicates that the market may be too relaxed about future rate paths after summer. We see a chance to bet on rising volatility, as any unexpected data could lead to rapid changes in the Treasury curve. Waller’s acknowledgment of uncertainty surrounding the long-term neutral rate, which he estimates to be near 3%, suggests caution regarding long-term interest rate positions. The 10-year Treasury yield has fluctuated between 4.2% and 4.7% for months, reflecting this uncertainty. This indicates that the final rate for this cutting cycle is still up in the air. His cautious view on reducing the balance sheet, especially the slow pace of mortgage bond sales, should support risk assets. The Federal Reserve is clearly trying to avoid a repeat of the 2019 repo market issues, which were partially caused by too aggressive balance sheet reductions. This careful approach lowers the chance of sudden tightening in financial conditions due to quantitative tightening. Create your live VT Markets account and start trading now.

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