The “surrender” of bond traders predicts that the Fed will cut interest rates 4-5 times this year, by 25 basis points each time, close to the Fed's guideline of cutting interest rates 3 times. This is in stark contrast to last December's bet on cutting interest rates starting in March, and the rate cut was as high as 175 basis points.
Hopes that the Federal Reserve will cut interest rates starting in March are getting slim, and bond traders have finally learned the oldest lesson: don't go against the Federal Reserve! Current interest rates in the swap market show that bond traders predict that the Fed will cut interest rates 4-5 times this year, 25 basis points each time, close to the forecast that the Fed will cut interest rates 3 times.
On February 12, media reported that the sudden banking crisis in March last year made bond traders mistakenly bet that the Federal Reserve would be forced to stop raising interest rates, causing them to suffer significant losses due to the sharp drop in treasury bond prices in 2022.
In December of last year, when Federal Reserve Chairman Jay Powell suddenly changed, traders began betting again that the Federal Reserve would cut interest rates drastically. Starting as early as March, the maximum rate cut reached 175 basis points. This is a huge difference from the Federal Reserve's suggestion of cutting interest rates 3 times, 25 basis points each time.
However, after a series of economic data was released, Fed officials emphasized one after another that they are not prepared to start cutting interest rates until inflation is set to move towards the 2% target, and that bond market traders will have to re-examine their expectations of interest rate cuts.
Media analysis indicates that bond market traders are gradually keeping pace with the Federal Reserve in order to reduce market accidents and potential losses that may be caused again.
Ari Bergmann, founder of Penso Advisors, said that the information obtained from the Federal Reserve's statement was that they wanted to cut interest rates with insurance, and they saw that inflation was falling. “I think the current market pricing is appropriate.”
The Fed's interest rate cut is “a foregone conclusion”, and the economy is expected to have a “soft landing”
More than six months have passed since the Federal Reserve carried out the “last plus” of the current austerity cycle on July 26, 2023.
Inflation declined steadily during this period, and the Federal Reserve's favorite core PCE price growth rate hit a new low of nearly 3 years in December. Wall Street expects the January CPI to be released tomorrow to rise 3.7% year on year, the smallest year-on-year increase since April 2021.
The year-on-year and month-on-month growth rates of the US CPI rebounded above expectations. The core CPI growth rate remained flat, and “rising” inflation weighed down expectations of interest rate cuts in March. Both 2024 Federal Reserve voting commissioners said they needed to see more evidence of a decline in inflation, and until then they remained cautious about cutting interest rates.
However, since core inflation has not heated up, the market's interest rate cut expectations are still strong. Nick Timiraos, known as the “New Federal Reserve News Agency,” wrote:
The CPI report is unlikely to change the Fed's policy outlook in the near future. Inflation data for the next few months is likely to have a greater impact on when the Federal Reserve first cuts interest rates.
Meanwhile, the number of non-farm payrolls in the US surged in January. GDP for the fourth quarter of last year far exceeded expectations. Goldman Sachs raised the 2024 GDP growth forecast by 0.3 percentage points to 2.4%. A series of data shows that the US economy is still resilient, and the prospects for a “soft landing” are becoming more and more clear.
Due to unexpectedly strong economic data, the market expects that the possibility that the Federal Reserve will cut interest rates for the first time in May is as high as 90%, and that the possibility of cutting interest rates in March falls back to 17.5%.
The Federal Reserve strives to downplay expectations of short-term interest rate cuts
Last week, three Federal Reserve officials took turns shouting to lower expectations for the market, saying they had found no reason to cut interest rates urgently, and hinted that interest rate cuts would have to wait until May at the earliest.
Federal Reserve Governor Adriana Kugler said that investors have lowered their bets on the March interest rate cut and set their sights on May 1, but they have not completely abandoned their expectations of the March interest rate cut. Kugler, who spoke publicly for the first time since joining the Federal Reserve in September, said she was optimistic about progress in the fight against inflation, but did not reveal a schedule for possible interest rate cuts. Kugler said, “At some point, inflation and the continued slowdown in the labor market may become an opportunity to cut interest rates.”
Collins, who did not have the right to vote this year, said that she is looking for evidence that the inflation rate has reached the 2% target and will not take action to cut interest rates until it is found. This step may not be taken until later this year.
Kashkari, who also did not have the right to vote this year, said in an interview that officials would like to observe several more months of inflation data before cutting interest rates. He predicts that interest rates may be cut two to three times in 2024.