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Investors have fallen into line with the Federal Reserve’s expectation that it will cut interest rates just three times this year, ending a months-long stand-off between markets and the central bank.
Following a run of economic data signalling 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 bet on almost a full percentage point of cuts by December. In January, they were pricing in between six and seven quarter-point cuts by the end of 2024.
“The market has been brought to heel,” said Padhraic Garvey, head of research for the Americas at ING, arguing that the persistence of inflation had forced investors to back down.
US stocks fell on Friday as traders trimmed their bets on interest rate cuts, with the benchmark S&P 500 falling 0.6 per cent and the tech-heavy Nasdaq Composite down 1 per cent.
The markets’ alignment with the Fed’s forecast of three cuts from their 23-year high of 5.25 per cent to 5.5 per cent 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 rate cut by June at just two in three. Last month they gave a 100 per cent probability to a reduction by June.
“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.
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As well as February’s unexpected increase in inflation to 3.2 per cent, separate data this week showed a 0.6 per cent 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 when it announces its decision on March 20.
Fed chair Jay Powell said this month the central bank was “waiting to become more confident that inflation is moving sustainably to 2 per cent” before cutting borrowing costs.
“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 yield on two-year Treasuries, which tracks interest rate expectations, has risen this week about 0.25 percentage points to 4.73 per cent.
Official data last week showed the US added more jobs than expected in February. While the unemployment rate rose to 3.9 per cent from 3.7 per cent the month before, it remains low by historic standards.
Brent crude, the international benchmark, settled 0.1 per cent lower at $85.34 a barrel on Friday.
Additional reporting by Stephanie Stacey
Source: Economy - ft.com
