Investors who for months had been banking on the Federal Reserve cutting interest rates this year have been forced to back off those bets after a raft of strong US economic data that suggests persistent inflation.
Futures markets at the start of February signalled that the US central bank would reduce interest rates at least two times by the end of the year. This week they suggested roughly equal chances of one rate cut or none at all at the Fed’s monetary policy meetings in 2023.
The move in futures shows investors merging closer to the Fed’s own message that it will not lower rates until at least 2024. “The market is coming in line with the Fed,” said Priya Misra, head of global rates strategy at TD Securities. “The Fed is data dependent, and we have seen better than expected data.”
The US on Tuesday reported that consumer prices in January had cooled by less than expected, with housing costs in particular bolstering inflation. On Wednesday came statistics that US retail sales, which include items like food and petrol, rose 3 per cent last month, well above forecasts of a 1.8 per cent increase.
“The data this week has brought a dose of reality to markets,” said Kristina Hooper, chief global market strategist at Invesco US.
The data followed a US employment report for January which showed the labour market running hot, adding nearly three times the number of jobs forecast. The strong economic indicators come as the Fed has slowed its pace of monetary tightening, lifting its main policy rate by 0.25 percentage points in February after rises of 0.75 and 0.5 percentage points for most of 2022.
Prior to the release of the January jobs report, futures markets pointed to the Fed’s benchmark interest rate peaking at 4.9 per cent in the second quarter before dropping to around 4.4 per cent by the end of the year, implying two interest rate cuts of 0.25 percentage points apiece.
On Wednesday, pricing showed that investors expect rate rises in March and May, with a peak in rates at 5.25 per cent, but then a less than 0.25 percentage point cut by the end of 2023, equivalent to a virtual coin flip between one cut or zero.
Bets on where rates will stand by the end of 2024 have changed even more dramatically, rising from expectations at the start of February of around 2.9 per cent to 3.7 per cent this week.
Changes in rate expectations have been accompanied with changing wagers on inflation. The so-called one-year break-even inflation rate, showing where investors believe inflation will be in a year’s time, has risen from 2.1 per cent at the start of February to 2.9 per cent.
That all puts the market more in line with the Fed’s own forecasts from December. Surveyed officials saw interest rates ending this year at around 5.1 per cent, and 2024 at around 4.1 per cent. They envisaged inflation at 3.5 per cent by the end of 2023, and 2.5 per cent by the end of 2024, as measured by the personal consumption expenditures price index.
“The tone is being set by the payrolls numbers and it has been augmented by the inflation data, which suggests a scenario in which inflation is much stickier,” said Alan Ruskin, chief international strategist at Deutsche Bank.
