Investors who had been betting for months that the US Federal Reserve would cut interest rates this year were forced to back down those bets after a string of strong US economic data pointed to persistent inflation.
Futures markets signaled in early February that the US Federal Reserve would cut interest rates at least twice by the end of the year. This week at the Fed’s monetary policy meetings in 2023, they proposed roughly equal odds of a rate cut or no rate cut at all.
The move in futures shows investors are getting closer to the Fed’s own message that it won’t cut rates until at least 2024. “The market is converging with the Fed,” said Priya Misra, head of global rates strategy at TD Securities. “The Fed is data dependent and we’ve seen better than expected data.”
The US reported on Tuesday that consumer prices had cooled less-than-expected in January, with housing costs in particular supporting inflation. On Wednesday came statistics that U.S. retail sales, which include items like groceries and gasoline, rose 3 percent last month, well above forecasts for a 1.8 percent rise.
“This week’s data has brought a dose of reality to the markets,” said Kristina Hooper, chief global market strategist at Invesco US.
The data followed a US jobs report for January that showed the job market was heating up and job creation was nearly three times higher than forecast. The strong economic indicators come as the Fed slowed its pace of monetary tightening, raising interest rates by 0.25 percentage points in February after raising 0.75 percentage points and 0.5 percentage points for most of 2022.
Ahead of the release of the January jobs report, futures markets pointed out that the Fed’s benchmark interest rate peaked at 4.9 percent in the second quarter before falling to around 4.4 percent by the end of the year, marking two 0. 25 percent implied points each.
On Wednesday, pricing showed investors expect rate hikes in March and May, with rates peaking at 5.25 percent but then falling less than 0.25 percentage point by the end of 2023, a virtual coin toss between a or more interest rate cuts equals zero.
Bets on where rates will stand by the end of 2024 have shifted even more dramatically, rising from around 2.9 percent expected in early February to 3.7 percent this week.
Changes in interest rate expectations have been accompanied by shifting bets on inflation. The so-called one-year breakeven inflation rate, which indicates where investors expect inflation to be a year from now, has risen to 2.9 percent from 2.1 percent in early February.
This all brings the market more in line with the Fed’s own forecasts from December. Officials interviewed saw interest rates ending at about 5.1 percent this year and 4.1 percent in 2024. They forecast inflation of 3.5 percent by the end of 2023 and 2.5 percent by the end of 2024, as measured by the personal consumption expenditure price index.
“The tone is being set by the payroll data and has been reinforced by the inflation data, pointing to a scenario where inflation is much tougher,” said Alan Ruskin, chief international strategist at Deutsche Bank.
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