Investors are beginning to debate how the Federal Reserve will manage a U.S. economy that won't land, and some are debating the need for a rate hike even weeks after market forecasts of steady rate cuts seemed a foregone conclusion.
Betting on rate cuts was so widespread a few weeks ago that Fed Chairman Jerome Powell publicly warned that policymakers were unlikely to cut rates before March. Less than three weeks later, swaps showed that traders were not only ruling out a rate cut in March, but that a rate cut in May was also unlikely, and even confidence in a Fed rate cut in June was wavering.
The hot discussion recently is: Maybe the next round of salary increases will not be salary cuts at all. Former U.S. Treasury Secretary Lawrence Summers expressed what many market participants are already thinking on Friday (February 16): "The next move is likely to be to raise interest rates."
Even if another rate hike is hard to swallow, some Fed watchers believe a repeat of the late 1990s could happen: a brief period of rate cuts to prepare for subsequent rate hikes.
"There are a lot of possible, plausible outcomes," said Earl Davis, head of fixed income and money markets at Bank of Montreal Global Asset Management. While he insisted on a 75 basis point rate cut in 2024, he said, "It's hard for me to be confident about that." Say it."
There are more voices predicting “interest rate hikes” in the market
As for Fed policymakers, none have publicly signaled further interest rate hikes in recent weeks. "We believe our policy rate is likely to be at the peak of this tightening cycle," Powell said on January 31. San Francisco Fed President Daley, considered a centrist, said on Friday that a 75 basis point rate cut in 2024 is "Reasonable baseline expectations".
At the same time, the Fed has not provided "forward guidance" on its medium-term policy framework as it has in the past, leaving investors with even less sense of direction. Volatile economic data this month has driven moves in U.S. Treasuries, futures and swaps.
Bond yields climbed sharply last week after consumer and producer price index (PPI) data beat market expectations. The key component of service prices in the Consumer Price Index (CPI) recorded the largest increase in the past two years. Job growth also beat market expectations in January, although retail sales data showed a decline in January, defying other signs that the economy was growing beyond its long-term potential.
Last week, two-year, three-year and five-year Treasury yields all reached their highest levels since early December.
"The final stretch of this inflation battle is going to be bumpy," said Lindsay Rosner, head of multi-sector fixed income investing at Goldman Sachs Asset Management. "It's really going to be a bit like a ping-pong game at every data point."
Rosner said she agreed with Summers' assessment of the risks of raising interest rates, but she believed "it makes more sense to keep interest rates at current levels for an extended period of time," a move that would ensure the Fed keeps inflation in check.
Summers is a professor at Harvard University and a paid contributor to Bloomberg Television. He believes that the probability of the Federal Reserve raising interest rates next is 15%. Mark Nash, who manages the absolute return macro fund at Jupiter Asset Management, puts the possibility at 20%.
Even some anticipating rate cuts advocate insuring the bet. Bank of Montreal's Davis has been shorting two-year Treasuries since December, but has covered half of his position since the start of the year as interest rates have climbed.
Kit Juckes, chief FX strategist at Société Générale, told clients in a note last week that if "the U.S. economy accelerates again, the Fed will eventually have to tighten monetary policy again and the dollar will rebound," possibly back to 2022 levels High Point.
The possibility of “interest rate hike” is being digested
A Bloomberg Intelligence analysis of short-term interest rate options showed that after last Tuesday's CPI release, traders began to price in the possibility of the Federal Reserve raising interest rates next year.
David Robin, a strategist at TJM Institutional who has worked in the debt derivatives market for decades, said another driver of demand for unusual options is that they are an inexpensive way to build a bulletproof portfolio based on base cases.
"People are trying to figure out where their portfolios are going to blow up and hedge against that," Robin said. He expects the Fed to cut interest rates two to three times this year.
Citigroup strategists said there should be more hedging against the risk that the Fed might engage in only a very brief easing cycle, followed by a rate hike soon after. Economists at the bank expect the Fed to cut interest rates for the first time in June. The bank also believes that the situation of the late 1990s may be repeated in the next few years.
Ira Jersey, chief U.S. interest rate strategist, said: "Just a month ago, people were not hedging against the possibility of rising interest rates, and now, at least some investors appear to be doing so. The market has already priced in the possibility that the Federal Reserve will take action. One-way distribution of measures. The long-tail effects of low interest rates remain, but this shift is important."
In 1998, officials cut interest rates three times in a row to shorten a financial crisis triggered by Russia's debt default and the near-collapse of hedge fund Long-Term Capital Management. Subsequently, the Federal Reserve began a cycle of interest rate hikes in June 1999 to curb inflationary pressures.
Pacific Investment Management Company economist Tiffany Wilding believes that in addition to unstable domestic economic data, there are also international factors. Among them: Conflict in the Red Sea and drought slowed the Panama Canal, and shipping disruptions led to higher freight costs.
All this could lead to "stop-and-go easing," Wilding said. "The risk is there and it's difficult to predict."
Bank of Montreal's Davis said the bottom line for interest rate markets in 2024: "There will be extreme volatility on both sides."
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2024-02-21
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