The Fed Cuts, but Remains Offside

After today's Fed Funds cut of 25 basis points (or 0.25%) the Fed Mistake Index falls to +50. Historically, the Fed Mistake Index averages -50. The Chairman and the Fed remain 100 basis points offside.

The best predictor of the Fed Funds Rate is the 2-Year US Treasury. This makes sense. The market aggregates all of the various market participants' opinions about where rates are going and lets them wager on it. Of course this indicator is better than a room full of PhD's, no matter how smart they are, in sorting out the direction of Fed policy. The metric is so good that the two rarely veer that far from each other. When they do, that is useful information. The 2-Year yield is 3.5%. The overnight Fed Funds Rate is 4%-to-4.25%. Intuitively, the 2-Year yield should be higher than the Fed Funds rate, not lower. The fact that the US Government currently pays more on its overnight rate than it does to borrow for two years is strange, temporary, and a signal. On average, the Fed Funds rate is -50 basis points lower than the 2-Year US Treasury. Cumulatively, the market is holding up an offside flag. The Fed is nearly 100 basis points offside.

Look for the Fed to keep cutting.