How the financial markets are caught off guard again by their “Fed-stop-soon” trading

Published: April 14, 2023 at 2:14 PM ET

A combination of hawkish statements from two Federal Reserve officials, solid earnings reports from banks and a rebound in consumer sentiment on Friday are among the factors contributing to another abrupt realignment in financial markets’ thinking about the course of interest rates. The sudden readjustment invalidated popular belief that the Federal Reserve could be nearing the end of its year-long cycle of interest rate hikes. All three major US stock indexes, DJIA SPX COMP, fell during afternoon trading as Treasury yields surged higher led by a 19 basis point rise in 1-month T-Bill rate BX:TMUBMUSD01M with …

A combination of hawkish statements from two Federal Reserve officials, solid earnings reports from banks and a rebound in consumer sentiment on Friday are among the factors contributing to another abrupt realignment in financial markets’ thinking about the course of interest rates.

The sudden readjustment invalidated popular belief that the Federal Reserve could be nearing the end of its year-long cycle of interest rate hikes. All three major US stock indices

DJIA

SPX

COMP

fell during afternoon trade as Treasury yields surged higher – led by a 19 basis point rise in the 1-month T-bill rate

TMUBMUSD01M

— along with the ICE US Dollar Index

DXY

.
Meanwhile, Fed funds futures traders increased the chances of Fed rate hikes in May and June while reducing their expectations for rate cuts later this year.

“Everything the market believed at the close yesterday has been disproved today,” said Steve Englander, New York-based head of global G10 FX research and North America macro strategy for Standard Chartered. As he put it, “everything went wrong in the ‘Fed-will-stop-soon’ trade,” although any future spillover of bank stress has the potential to shorten policymakers’ rate-hiking cycle.

Friday’s data included a report from the University of Michigan that showed consumer sentiment was creeping up and Americans were becoming more concerned about high inflation. And although retail sales fell more than expected in March, some people saw the potential for deeper weakness, Englander said. In addition, JPMorgan Chase

JPM

and Citigroup Inc.

C

released first quarter results that delighted investors.

See: JPMorgan Chase stock is performing positively for the year after beating previous earnings and revenue estimates

Meanwhile, two policymakers stepped in the Fed’s lap with hawkish comments. Fed Governor Christopher Waller said he sees the need for the central bank to continue raising rates, while Atlanta Fed President Raphael Bostic told Reuters that the latest inflation data “consistent with us moving again.” .

As a result, Fed funds futures traders assessed a roughly 80% or better chance of another quarter-point rate hike in May, which would raise the Fed’s main rate target to between 5% and 5.2%. and they increased the likelihood of a similarly sized move to 20% in June, up from 4.7% a day earlier, according to the CME FedWatch Tool.

“The million-dollar question is, ‘How much more does the Fed have to do?'” said Rob Daly, director of fixed income at Glenmede Investment Management in Philadelphia. “I’m in the camp that thinks there could be another hike or two, but the next question is, ‘How long are they going to keep rates up?'”

“Risk assets have remained incredibly resilient, we’ve seen a very strong labor market and inflation is still high,” Daly said over the phone. “I see no reason why the Fed should cut rates anytime soon. The data has been robust and not necessarily weak enough for the Fed to change course.”