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Moody's: Fed likely to cut rates this year if 10-year yield falls further

The Federal Reserve will cut its key interest rate for the first time since the Great Recession if 10-year Treasury bond yields continue their slide a little more to drop below below 2.4%, Moody's Analytics said in a March 21 report.

The Fed on March 20 kept its benchmark federal funds rate at a target range of 2.25% to 2.5% and signaled that its next rate hike may not come until 2020, after previously signaling multiple 2019 rate rises. The Fed also downgraded its median projection for 2019 GDP growth and announced a plan to slow its efforts to reduce its $4 trillion balance sheet, saying the program of cutting its assets each month will wrap up at the end of September.

The decisions, which marked a dovish shift from prior rate expectations, triggered a rally in U.S. Treasurys.

The 10-year Treasury yield fell to about 2.52% shortly after the Fed decision, from about 2.59%. Moody's said an even deeper slide in Treasury bond yields "will increase the likelihood of a Fed rate cut" and raised the likelihood of a December 2019 cut to 39%. The analysts posited that a drop below 2.4% will trigger a rate cut.

Yields on 10-year Treasurys continued falling March 22, causing a portion of the yield curve to invert, where longer bonds carry a lower rate than shorter ones. Just before noon ET, 10-year Treasurys were down to 2.428%, below the yield on a 3-month Treasury bill, which stood at 2.462%.

The agency added that a lowering of the fed funds rate target midpoint to 2.125% could occur as early as the Fed's June meeting if nonfarm payroll employment fails to significantly improve from the lower-than-expected 20,000-job gain in February.

Moody's slashed the odds of a June hike to 10% from 25% and of a September rate increase to 20% from 35%. Chances of a December fed funds rate increase were cut to 30% from 40%.

"A probabilistic forecasting approach, which is based on the subjective probabilities of a fed hike versus a cut, would put the fed funds rate at 2.5% at the end of this year, implying less than one rate hike," the report said.