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Investors have fallen in line with the Federal Reserve’s expectations of cutting interest rates only three times this year, after a months-long stalemate between markets and the central bank.
Following a slew of economic data signaling that U.S. inflation is stubbornly high, traders on Friday were pricing in rate cuts of just three-quarters of a point by the end of the year, according to data compiled by LSEG.
Before Tuesday’s unexpected spike in U.S. inflation, investors had expected cuts of nearly a full percentage point by December. In January they bet on six to seven quarter-point cuts by the end of 2024.
“The market has been brought to its knees,” said Padhraic Garvey, head of Americas research at ING, arguing that persistent inflation has forced investors to back off.
U.S. stocks opened lower Friday as traders scaled back their bets on interest rate cuts, with the benchmark S&P 500 down 0.6% just after the opening bell and the Nasdaq Composite, higher technology, down 1.1%.
The markets aligning with the Fed’s forecast of three cuts from current 23-year highs marks a big shift as investors adjust to the slower-than-expected decline in inflation in a crucial U.S. election year.
Markets now believe the chance of an interest rate cut by June is only one in three. Last month they gave a 100% chance of a reduction by June from the current level of 5.25% to 5.5%.
“It looks increasingly likely that we will end up with a short, superficial rate cut cycle this time around,” said Mark Dowding, chief investment officer at RBC BlueBay Asset Management, who argued that the Fed may still need to hold rates. relatively high rates to fend off inflation.
In addition to the unexpected rise in inflation to 3.2% in February, separate data this week showed a 0.6% month-on-month increase 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 expects to keep rates unchanged at next week’s meeting.
Fed Chair Jay Powell said this month that the central bank is “waiting to gain greater confidence that inflation is moving sustainably to 2%” before cutting borrowing costs.
“There is still a real risk that strong economic data will prevent the Fed from cutting interest rates in the coming months,” said Ellie Henderson, an economist at Investec.
The yield on two-year Treasury bonds, which track interest rate expectations, rose this week by 0.23 percentage points to 4.71%.
Official data last week showed the United States created more jobs than expected in February. Although the unemployment rate rose to 3.9% from 3.7% the previous month, it remains low by historical standards.
Oil prices also rose to their highest level since November on Thursday, which could help keep inflation above the Fed’s 2% target for longer.
Additional reporting by Stephanie Stacey