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US investors have become more cautious than the Federal Reserve on expectations of interest rate cuts this year, betting the central bank could reduce rates fewer than three times after a spate of strong economic data.
Swap markets on Tuesday priced in just 0.68 percentage points of cuts by December, fewer than the 0.75 percentage points of cuts that the Fed has projected.
Traders have also scaled back expectations on when those rate cuts will start slightly, putting the odds of a move in June at around 63 per cent, after data in the last week suggested the economy was growing while inflation remained sticky.
The Fed has since December signalled it expected to cut its key interest rate by the equivalent to three quarter-point cuts, from the current range of 5.25 to 5.5 per cent. Up until the Fed’s March meeting, markets were betting that policymakers would make more cuts as inflation decelerated and growth slowed. Derivatives markets in January priced in as many as six or seven cuts.
“The market is clearly trying to push back on the expectations from the Fed’s median dots,” said Subadra Rajappa, head of US 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 released at the bank’s March meeting.
“But we’re going to need to see data like [inflation] next week that will corroborate the pushback to [a June cut].”
On Monday, US manufacturing unexpectedly expanded 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 for its target — accelerated at a pace of 2.5 per cent in February, slightly faster than in January.
Also moving on Tuesday morning was the benchmark 10-year Treasury yield, which rose to a peak of 4.4 per cent, its highest level since November. The benchmark yield fluctuates with inflation and growth expectations, which explains why the moves have been so significant this week.
Rajappa cautioned that the bias in the market was still towards the Fed easing monetary policy this year. “I think we’re going to 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 was down 0.8 per cent in mid-morning trade in New York and the tech-heavy Nasdaq Composite had dropped 1.3 per cent.
Traders in Europe have also dialled 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 for each at the start of the year.
Benchmark borrowing costs in the UK surged on Tuesday after official figures also showed UK manufacturing activity had 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, up from 47.5 in February and above the flash reading of 49.9, pushing 10 year gilts yields up 0.15 percentage points to 4.09 per cent.
Additional reporting by George Steer in New York
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