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U.S. investors have become more cautious than the Federal Reserve about expectations for interest rate cuts this year, betting that the central bank could cut rates less than three times after a wave of strong economic data.
Swaps markets on Tuesday were forecasting cuts of just 0.68 percentage points by December, less than the 0.75 percentage point cuts the Fed had forecast.
Traders also scaled back expectations for when rate cuts will begin slightly, bringing the odds of a move in June to around 63%, after last week’s data suggested the economy was growing while inflation remained sticky.
Since December, the Fed has signaled that it plans to cut its benchmark interest rate by an amount equivalent to three-quarter-point cuts, from the current range of 5.25 to 5.5%. Until the Fed’s March meeting, markets were betting that policymakers would make further cuts as inflation slowed and growth slowed. Derivatives markets priced in as many as six or seven cuts in January.
“The market is clearly trying to push back expectations from the Fed’s midpoints,” said Subadra Rajappa, head of U.S. rates strategy at Société Générale, referring to the Fed’s so-called “dot plot,” which shows officials’ projections for future rate cuts and was last published at the bank’s March meeting.
“But we will need to see data like [inflation] next week this will confirm the pushback [a June cut].”
On Monday, the U.S. manufacturing sector unexpectedly grew in March for the first time since 2022. And last week, the Commerce Department reported that the personal consumption expenditures price index — the measure of inflation the Fed uses towards its goal – accelerated at a pace of 2.5 percent. cent in February, slightly faster than in January.
The yield on the benchmark 10-year Treasury bond also moved Tuesday morning, rising to a peak of 4.4%, its highest level since November. The benchmark yield fluctuates with inflation and growth expectations, which explains why the movements have been so significant this week.
Rajappa warned that the market appetite is still for the Fed to ease monetary policy this year. “I think we will see continued resistance to yields moving much higher, because the bias towards easing is still strong.”
The move in yields sent stocks lower: The blue-chip S&P 500 fell 0.8% in mid-morning trade in New York and the tech-heavy Nasdaq Composite fell 1.3%.
Traders in Europe have also scaled back their expectations for interest rate cuts in recent weeks. Markets are betting on 0.68 percentage points of cuts from the BoE this year and 0.90 percentage points from the European Central Bank, down from more than 1.5 percentage points each at the start of the year .
Benchmark borrowing costs in the UK rose on Tuesday after official data also showed that British manufacturing activity unexpectedly returned to growth for the first time in two years.
The S&P Global UK manufacturing purchasing managers’ index rose to 50.3 in March, from 47.5 in February and above the flash reading of 49.9, pushing 10-year gilt yields higher by 0.15 percentage points to 4.09%.
Additional reporting by George Steer in New York