Fed serves up a tasty rate cut; Fed funds rate could drop to 3% by mid-2025

September 27, 2024

The Takeaway is a CoBank publication that provides practical commentary on interest rates, derivatives and capital markets activities. These insights come from the professionals in CoBank’s Treasury, Customer Derivatives and Capital Markets groups, and other leaders across the bank—people who are in the market interacting with customers, investors and other lenders seeking to understand what is driving activity.

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Interest rates: A whopper of a rate cut prompts a super-sized question…recession?

The Fed used its first rate cut in more than four years to serve up a tasty meal. A Big Mac and a Whopper combined. Add extra-large fries and a 32 oz. shake, and you get an idea of what’s cooking at the Fed.

The Fed cut its benchmark fed funds rate by 1/2 percentage point to a range of 4.75% to 5% at its September 18 meeting. The sizeable cut points to confidence that the Fed has inflation under control and economic activity will continue to expand. Unemployment, while increasing of late, remains low.

The table is set for additional rate cuts yet this year and in 2025.

“The market had priced in a 50-50 chance between a 25- and 50-basis-point cut,” said Jeff Milheiser, vice president, Funding & Investments in CoBank’s Treasury group. “Some of the labor data softened, and the market pricing in a decent chance of a 50-basis-point cut gave the Fed the opportunity to go ahead and cut more than they had originally thought to kick off the easing cycle. 

“It could be a signal that some data were softer than expected,” he continued. “Still, the expectation is not necessarily that they’ll continue at a 50-basis-point clip. They’re projecting that they’ll at least keep cutting at the final two meetings to finish out 2024.” 

Milheiser noted that the Fed’s comments and market expectations are substantially aligned.

“Data indicate that there isn’t full agreement within the Fed on whether to make two full 50-basis-point cuts or even two 25-basis-point cuts in its two remaining 2024 meetings,” said Milheiser. “It's between 50 and 75 basis points for the two meetings in total, suggesting the possibility of one 50- and one 25-basis-point cut.

“The market is pricing in about 75 basis points in cuts by year end, but it’s not clear when they expect the 50 to come, whether it’s November or December,” he added. “The market also expects the Fed to continue cutting rates to get to 3% by mid-2025, which is near expectations for a neutral rate.”

So, recession?

Milheiser said the outlook among most strategists and economists is for a soft landing.

“The base case suggests a soft landing,” he concluded. “There is a widely held view that the Fed is doing the right thing and while there is a slowdown in the labor market and economy in general, there’s no reason to expect that a recession is imminent.”

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Interest rate management: A whole new world—uncertainty and volatility versus favorable rate trajectory 

The Fed’s interest rate cut and the market’s expectation for additional cuts are impacting customer hedging strategies, according to Eric Nickerson, CoBank sector vice president of Customer Derivatives.

One of the factors affecting customer behavior is an ongoing disinversion of the interest rate yield curve. The rate decrease has caused the yield curve to begin to normalize, where short-term rates have come down and longer-term rates are higher.

“As it became clear that the Fed would begin its easing cycle, we saw a fair amount of volatility,” Nickerson said. “That generated customer interest in taking advantage of the lower longer-term rates that we’ve seen over the last couple of months, and then also taking advantage of the inversion in the yield curve. 

“But coming into the Fed meeting, we saw some disinversion of the yield curve,” he continued. “Based on recent customer discussions, our expectations are for less hedging activity through the easing cycle because there is some hesitation to lock in long-term rates while short-term rates are declining.  

“That said, there is an awareness among many customers we are talking with that the forward curve is not, historically, a good predictor of what actually happens,” Nickerson said. “Some customers are seeing the market’s implied rate trajectory as an opportunity to lock in what they view as expectations for an aggressive easing cycle.”

Nickerson added that several customers are also showing renewed interest in options to lock in a range of possible outcomes, e.g., an interest rate collar, which would provide upside protection in case the market is wrong, but still provide additional downward benefit.

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Capital markets: Commercial benchmark rate alphabet soup becomes clearer; BSBY sunsets in November

It has been just over a year since the final cessation of the scandal-ridden London Interbank Offered Rate in favor of the Secured Overnight Financing Rate, which has become the predominant commercial banking benchmark lending rate.

While most commercial lending activity now has transitioned to the SOFR benchmark, two other rates—the Bloomberg Short-Term Bank Yield Index and the American Interbank Offered Rate—were introduced as potential alternatives to SOFR as a LIBOR replacement by compensating for SOFR’s initial limitations.

With SOFR having taken root, BSBY, which is administered by Bloomberg Index Services Limited, will permanently end on November 15, 2024.

Bloomberg began publishing BSBY in 2021 to generate licensing fees by filling SOFR’s gaps. 
Similar to LIBOR, BSBY has a 1- to 12-month term structure whereas SOFR is an overnight rate. And BSBY, also like LIBOR, reflects banks’ credit risk whereas SOFR is a riskless rate backed by U.S. Treasuries.

The market eventually caught up when CME Group, the leading derivatives marketplace, developed Term SOFR indexes, which satisfied the term gaps BSBY was looking to fill. The market also addressed SOFR’s credit risk issue by using credit spread adjustments, making BSBY yet more redundant.

The result is bye-bye BSBY. What about thinly used AMERIBOR, which is used mostly by regional banks? Time will tell.

Market Focus

Agribusiness

Crisis averted? Farmers move ’23 inventory to market on deferred-price contracts

The head-on collision between farmers who have been holding their 2023 grain inventory and grain elevators that need to clear out space for new crop bushels seems to have been avoided.

In a solution to what looked like a high-speed game of chicken played out in slow motion, many farmers have moved their inventories to the market driven by aggressive deferred-price contracts from grain elevator operators, according to Marcus Wilhelm, Western region president of CoBank’s Agribusiness Banking Group. Deferred price contracts transfer legal title of the inventory to the grain elevators, but the purchase price is to be determined.

“Many customers I’ve spoken with are going into the 2024 harvest—which has begun early—relatively empty, so they have the operational capacity to handle what looks to be a good-sized crop,” Wilhelm said. “Meanwhile, they’ve avoided getting caught in the basis shift from old crop to new crop, but that price will be paid by the farmer who is still holding out to set the price of deferred-price bushels.

“I wouldn’t necessarily call it a win for farmers, but more of a draw,” Wilhelm added. “Prices are still relatively lower than they were a year ago, but we’ve seen some modest improvement lately. We seem to be coming off the bottom, but farmers are still trying to figure out the harvest low. Have we seen it and are climbing up from here, or is it still to come?”

Wilhelm noted that ethanol crush margins remained healthy throughout the summer, which relieved some of the inventory that has moved to grain elevators.  

“We’ll see where the year-end numbers come in for our customers and how they handled it, but a potentially catastrophic outcome seems to have been avoided,” Wilhelm concluded.

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Digital Infrastructure

Big fish eats little fish: The next chapter in the wireless/fixed broadband consolidation story is about to begin

Verizon’s September 5 announcement that it would acquire Frontier Communications in a $20 billion all-cash deal is only the latest example of large wireless network operators pushing into broadband to revive revenue growth. There’s likely much more to come, according to Jeff Johnston, lead Communications economist at CoBank.

Not only will there likely be more such deals, but Johnston also believes the acquired companies will probably become acquirers themselves and begin snapping up smaller fixed broadband providers around the country.

“We’re likely to see Verizon, T-Mobile and others spend multiple billions of dollars acquiring regional fiber operators—like Frontier—which will use the backing of the national wireless operators to acquire a bunch of smaller, including rural, community fiber operators,” Johnston said. “That way, the fiber footprint can be built out strategically and enable the national wireless operators to own a fiber network they can bundle with their wireless plans, without concerns about the limitations of fixed wireless internet compromising the value of their bundles. 

“Wireless networks have limitations,” Johnston added. “You can only add a certain number of customers and see a certain amount of growth in a bundled strategy. I believe these acquired companies will turn into aggregators, which will help the wireless operators regenerate much-needed growth.” 

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USDA and New ERA recipients eager to finalize commitments in current administration

In a recent visit to Wisconsin, President Biden and U.S. Department of Agriculture Secretary Tom Vilsack revealed the first 16 recipients of funding under the $9.7 billion Empowering Rural America (New ERA) program.

Absent from the USDA’s September 5 announcement were the dollar value of the awards to all but one recipient—La Crosse, WI-based Dairyland Power Cooperative—which is receiving an investment of nearly $573 million. However, investments in Indiana-based Hoosier Energy ($675 million) and Michigan-based Wolverine Power Supply Cooperative ($650 million) were announced afterwards. The 13 remaining entities that made it past the competitive stage are in the underwriting process to receive an award, according to the USDA.

“Recipients are eager to hear and move forward with their New ERA commitments,” said Kevin Benson, executive director, Capital Markets with CoBank. “And the USDA should be similarly eager to finalize its commitments because, in both cases, you don’t know what changes an election could bring.”

Benson added that discussions between the USDA and New ERA recipients are confidential, so it isn’t possible to determine what additional long-term or bridge financing CoBank’s co-op customer-owners may need to supplement the New ERA funding until after an award is made. Still, there appears to be a growing desire to move promptly and CoBank is well positioned to support our customer-owners as they seek to maximize the benefits of the New ERA program.

The New ERA program was established as part of the Inflation Reduction Act of 2022 to help rural America transition to clean, affordable and reliable energy.

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