Stay informed with free updates
Simply sign up to the US interest rates myFT Digest — delivered directly to your inbox.
Investors have fallen into line with the Federal Reserve’s expectation that it will cut interest rates just three times this year, following a months-long stand-off between markets and the central bank.
Following a run of economic data signaling that US inflation is stubbornly high, traders were on Friday pricing in only three quarter-point rate cuts by the end of the year, according to data compiled by LSEG.
Before Tuesday’s unexpected rise in US inflation, investors had expected almost a full percentage point of cuts by December. In January, they had bet on between six and seven quarter-point cuts by the end of 2024.
US stocks opened lower on Friday as traders trimmed their bets on interest rate cuts, with the benchmark S&P 500 falling 0.4 percent shortly following the opening bell and the tech-heavy Nasdaq Composite down 0.7 percent.
“There is still the very real risk that the robust economic data prevents the Fed from cutting interest rates in the coming months,” said Ellie Henderson, an economist at Investec.
The markets’ alignment with the Fed’s forecast of three cuts from rates’ current 23-year high marks a big shift as investors adjust to inflation’s slower than expected fall in a crucial US election year.
Markets now put the chance of an interest rate cut by June at just one in three. Last month they gave a 100 percent probability to a reduction by June from the present level of 5.25 percent to 5.5 percent.
“It’s looking increasingly likely that we will end up with a short and shallow rate cutting cycle this time around,” said Mark Dowding, chief investment officer at RBC BlueBay Asset Management, who argued that the Fed may still need to keep rates relatively high to beat back inflation.
As well as February’s unexpected increase in inflation to 3.2 percent, separate data this week showed a 0.6 percent month-on-month surge in producer prices.
The Fed will meet next week to discuss the course of future rate cuts and will update its projections for the rest of the year. It is expected to keep rates on hold at next week’s meeting.
Fed chair Jay Powell said this month the central bank was “waiting to become more confident that inflation is moving sustainably to 2 percent” before cutting borrowing costs.
The yield on two-year Treasuries, which tracks interest rate expectations, has risen this week by 0.24 percentage points to 4.72 percent.
Official data last week showed the US had created more jobs than expected in February. While the unemployment rate rose to 3.9 percent from 3.7 percent the month before, it remains low by historic standards.
Oil prices also climbed to their highest level since November on Thursday, which might contribute to inflation staying above the Fed’s 2 percent target for longer.
Additional reporting by Stephanie Stacey
Analysis and Future Trends: The Implications of US Interest Rate Cuts
With investors now aligning themselves with the Federal Reserve’s expectations of only three interest rate cuts this year, a notable shift has occurred in the market. This adjustment comes following a period of uncertainty and standoff between the central bank and market forces. The decision to cut rates less frequently is based on recent economic data indicating persistently high US inflation.
Prior to the unexpected rise in US inflation earlier this week, investors had anticipated a significant decline with nearly a full percentage point of cuts expected by December. In fact, as of January, investors had even bet on a range of six to seven quarter-point cuts by the end of 2024. However, the current outlook reflects a more cautious approach, with traders now pricing in only three quarter-point rate cuts by year-end.
This shift in market sentiment has had an immediate impact on US stocks, with the benchmark S&P 500 and the tech-heavy Nasdaq Composite both experiencing declines. The decreased expectations of interest rate cuts raise concerns that robust economic data may restrict the Federal Reserve from implementing reductions in the coming months. Ellie Henderson, an economist at Investec, highlights this risk, emphasizing that market conditions may influence the central bank’s ability to act.
Looking ahead, the chances of an interest rate cut by June are now estimated to be one in three, a significant drop from the 100 percent probability assigned last month. This suggests a shift towards a short and shallow rate-cutting cycle, as Mark Dowding, Chief Investment Officer at RBC BlueBay Asset Management, suggests. Dowding argues that the Federal Reserve may need to maintain relatively high rates to combat inflation effectively.
The recent rise in US inflation to 3.2 percent in February, along with a month-on-month surge in producer prices, has contributed to concerns regarding the persistence of inflationary pressures. As the Federal Reserve convenes next week to discuss future rate cuts and update projections for the year, it is widely anticipated that rates will be kept on hold for now. Fed Chair Jay Powell has stressed the importance of sustained movement towards the 2 percent inflation target before considering further cuts.
The yield on two-year Treasuries, which serves as an indicator of interest rate expectations, has risen by 0.24 percentage points this week to 4.72 percent. This upward movement signifies a recalibration of market expectations, influenced by economic data and the Federal Reserve’s cautious approach.
In the broader economic context, recent data revealed that the US job market outperformed expectations in February, with more jobs created than anticipated. While the unemployment rate saw a slight increase from the previous month, it remains historically low at 3.9 percent. Additionally, oil prices reached their highest level since November, posing a potential risk to the Federal Reserve’s goal of maintaining inflation around the 2 percent target.
Looking into the future, these developments prompt a closer examination of emerging trends and potential implications for the industry. The market’s response to reduced expectations of interest rate cuts indicates a growing anticipation of a short and moderate rate-cutting cycle. In light of these trends, industry participants may consider reevaluating their strategies and adjusting risk profiles accordingly.
For investors, it becomes crucial to closely monitor economic data, particularly inflation indicators, as they will significantly impact the Federal Reserve’s decision-making process. A deeper understanding of the factors influencing inflation dynamics is key to making informed investment decisions.
Furthermore, the response of US stocks to interest rate expectations highlights the need for comprehensive risk management strategies. While market conditions may stabilize in the near term, volatility may persist as new economic data is released. Investors and market participants should remain agile and adaptive to navigate these uncertainties successfully.
As the Federal Reserve proceeds with its cautious approach, the market will be closely watching for signs of sustained movement towards the inflation target. Clear indications of progress in containing inflationary pressures might potentially pave the way for future rate cuts, providing relief to certain sectors of the economy.
In conclusion, the recent shift in market expectations regarding interest rate cuts has significant implications for investors and market participants. The Federal Reserve’s decision to cut rates less frequently reflects ongoing concerns regarding US inflation. Coupled with other economic indicators and emerging trends, it presents challenges and opportunities for industry players. Navigating this dynamic landscape requires a thorough understanding of market dynamics, continuous monitoring of economic data, and agile risk management strategies.