Investors predict the Federal Reserve will cut rates when it faces a slowing economy next year, betting that the US central bank is much closer to ending its historic monetary tightening campaign than it was. did not announce it.
Traders in the US government bond market are betting the Fed will be forced to cut interest rates twice in the fourth quarter of 2023. That’s despite protests from Chairman Jay Powell and other top officials this week that the central bank will not reverse course on its plans to keep borrowing costs high even if it slows the pace of its interest rate increases.
Treasury bill futures markets indicate that the Fed’s benchmark policy rate peaked in May at 4.9% before falling back to 4.4% by the end of 2023. This implies about 0.5 points discount percentage.
Bets on interest rate cuts next year gathered pace after Powell on Wednesday laid the groundwork for the Fed to end its run of interest rate hikes by 0.75 percentage points and move on. to a half-point rate hike at its December meeting. Investors also looked past a stronger-than-expected November jobs report released on Friday, which suggested little respite from inflation.
“I think it’s safe to say that the committee does not expect to cut rates next year. So how do we explain the difference between this perspective and what we expect? said Matt Raskin, head of US rates research at Deutsche Bank, who predicted the Fed would be forced to cut interest rates by 0.5 percentage points in December 2023.
“I think it boils down to market participants expecting a recession next year while the committee still has a soft landing in its forecast.”
Raskin cited the inversion of the yield curve – a widely used recession predictor – among other signals.
This view is consistent with the traditional pattern of rate hike cycles: in every cycle since 1980, with the exception of 2004-2006, the Fed has made cuts within six months of the peak in interest rates. .
“Generally they overtighten until something breaks. That will likely be the case in this cycle as well, so we wouldn’t rule out an adjustment at some point later next year,” Margaret said. Kerins, global head of fixed income strategy at BMO Capital Markets.
This goes against what officials have said. Powell on Wednesday was explicit that the central bank does not expect a policy about-face anytime soon.
“My colleagues and I don’t want to squeeze too much. Cutting rates is not something we want to do anytime soon, which is why we are slowing down,” the president told an audience at the Brookings Institution, while reaffirming the central bank’s commitment to bringing inflation back. to its long-standing target of 2%.
“Markets are trying to have their cake and eat it too, hearing Powell say he doesn’t want to overtighten, while ignoring the second half of the sentence where he says they’ll keep rates in restrictive territory,” said Calvin Tse, head of macro policy for the Americas at BNP Paribas. “The market has gone too far.”
Investors also warned that the shift in markets happened quickly and could easily be undone.
“The market is trading based on what it last heard from the Fed and what it expects from the next CPI print,” said Matthew Scott, chief trading officer. global rates at AllianceBernstein. “I don’t think anyone in the market really has much conviction about where the Fed stands at the end of next year.”
Economists polled by Bloomberg expect consumer prices in November to have risen just 0.3%, translating to an annual pace of 7.3%, the slowest rate since December 2021.
Earlier this week, John Williams, chairman of the New York Fed and one of Powell’s closest colleagues, also said he expects the central bank to keep rates at a level that puts the brakes on the economy at least until the end of next year when inflation moderates between 3% and 3.5%.
“I see a point, probably in 2024, where we start to lower nominal interest rates because inflation is coming down,” he said on Monday.
For Steven Abrahams, head of strategy at Amherst Pierpont, recent market price swings amount to “deja vu”.
“The market has been betting all year against the Fed keeping rates high through 2023. And the market has always been wrong,” he said.
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