Investors have adjusted their expectations in line with the Federal Reserve’s forecast of three interest rate cuts for the year, marking the end of a prolonged standoff between the markets and the central bank.
Recent economic indicators indicating persistent high inflation in the US have led traders to price in only three quarter-point rate cuts by the end of the year, according to data compiled by LSEG.
Before the unexpected rise in US inflation reported on Tuesday, investors had anticipated nearly a full percentage point of cuts by December. At the start of the year, their expectations ranged between six and seven quarter-point cuts by the end of 2024.
“The market has been brought to heel,” remarked Padhraic Garvey, head of research for the Americas at ING, attributing this shift to the enduring presence of inflation, which compelled investors to recalibrate their outlook.
US stocks opened lower on Friday as traders adjusted their expectations for interest rate cuts, with the benchmark S&P 500 dropping 0.6 percent shortly after the opening bell, and the tech-heavy Nasdaq Composite down 1.1 percent.
This alignment of market expectations with the Fed’s projection of three cuts from the current 23-year high in rates signifies a significant adjustment as investors grapple with the slower-than-expected decline in inflation, especially in a pivotal US election year.
Market sentiment now suggests a one-in-three chance of an interest rate cut by June. Last month, the probability of a reduction by June, from the current level of 5.25 percent to 5.5 percent, stood at 100 percent.
“It’s increasingly likely that we will witness a brief and modest cycle of rate cuts this time around,” observed Mark Dowding, chief investment officer at RBC BlueBay Asset Management, who suggested that the Fed might need to maintain relatively high rates to counter inflation.
In addition to February’s unexpected inflation surge to 3.2 percent, recent data revealed a 0.6 percent month-on-month increase in producer prices. The Fed, convening next week to deliberate on future rate cuts, is expected to keep rates unchanged at the upcoming meeting while revising its projections for the remainder of the year.
Federal Reserve Chair Jay Powell stated earlier this month that the central bank is “awaiting more confidence in sustained movement towards 2 percent inflation” before considering borrowing cost reductions.
“There remains a real risk that strong economic data could hinder the Fed’s interest rate cuts in the months ahead,” noted Ellie Henderson, an economist at Investec.
The yield on two-year Treasuries, reflecting interest rate expectations, has climbed by 0.23 percentage points to 4.71 percent this week.
Recent official data indicated higher-than-anticipated job creation in February, although the unemployment rate rose slightly to 3.9 percent from 3.7 percent the previous month, remaining historically low. Oil prices also surged to their highest level since November, potentially prolonging inflation’s deviation from the Fed’s 2 percent target.
