Published: February 16, 2023 at 12:56 pm ET
With the US economy and inflation proving to be far more durable than many expected, traders have boosted the odds of continued Federal Reserve rate hikes into June – a scenario that seemed unlikely a few weeks ago. Earlier this month the Fed’s key benchmark interest rate target was seen peaking at around 4.9%. On Wednesday and Thursday, however, traders were counting on a 52% chance that the Fed Funds’ rate target could rise to 5.25% to 5.5% or even higher by June — a level that hasn’t been seen for almost two decades or more was no longer achieved. That’s after accounting for three more quarter percentage points…
With the US economy and inflation proving to be far more durable than many expected, traders have boosted the odds of continued Federal Reserve rate hikes into June – a scenario that seemed unlikely a few weeks ago.
Earlier this month, the Fed’s key interest rate target was seen peaking at around 4.9%. On Wednesday and Thursday, however, traders were counting on a 52% chance that the Fed Funds’ rate target could rise to 5.25% to 5.5% or even higher by June — a level that hasn’t been seen for almost two decades or more was no longer achieved. This is after factoring in three more rate hikes of a quarter point each at each of the Fed’s next three meetings in March, May and June, although traders also saw growing chances for a larger half a point hike next month.
Financial markets are in the process of reassessing expectations of how high US interest rates could go after a series of stronger-than-expected US data, including Thursday’s January wholesale prices report, Wednesday’s retail sales figure, Tuesday’s CPI report, and a Blowout jobs report two weeks ago.
Not only have traders come closer to the Fed’s estimate of a 5.1% interest rate this year, some are now even exceeding it. The possibility of a bigger half-point Fed rate hike next month rose to 15% on Thursday from 12% a day ago, and the prospect of a 6% interest rate by September is on the map but is seen as extremely low 1.1% probability according to the CME FedWatch Tool. The key interest rate is currently between 4.5% and 4.75%.
“Investors, seeing the strength of the job market and consumer spending, are now wondering if the economy is really slowing. And unless it slows, the Fed is likely to rise a lot further into 2023 than we thought a few weeks ago,” said Tom Graff, head of investments at Baltimore-based Facet Wealth, which has $1.9 billion under management . “We don’t think a Fed Funds rate of 6% is very likely, but it’s a possibility worth considering.”
Until recently, investors and traders had mostly expected interest rate hikes to end soon. This was the case even though policymakers had already used their December roundup of economic forecasts to hint at the need for a 5.1% interest rate in 2023. Fed Chair Jerome Powell said the same thing at his Feb. 1 press briefing. The Fed needs to see “a lot more evidence” that price pressures are easing to worry that inflation is actually falling.
New comments from another Fed official on Thursday lent more weight to the possibility that policymakers might have to become aggressive again with the size of their next round of rate hikes: Cleveland Fed Chair Loretta Mester said she saw a “compelling” reason for a half point hike at the central bank from Jan 31 to Feb 2. 1 meeting where policymakers have instead hiked a smaller quarter-point step.
This week’s readjustments in interest rate expectations were seen as possibly preparing financial markets for further rounds of turmoil. All three major US stock indices on Thursday
SPX
DJIA
were down in afternoon trade but remained on course for weekly gains.
See: Bulls defiant in equity markets as Fed bond market capitulates. Here’s what to see.
The 10-year Treasury yield
TMUBMUSD10Y
headed for a fresh 2023 high of 3.83% while the 2-year rate
TMUBMUSD02Y
remained near the highest levels since November.
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