It has been a gradual process, taking months for traders to comprehend the once-unthinkable notion of potentially no rate cuts in 2024. Now, the tables have turned as they entertain the possibility of another hike by the U.S. central bank.
Shifting Perspectives
The realization dawned following last week’s consumer-price index for January surpassing expectations. Subsequently, the producer-price index for the same month underscored that the Federal Reserve’s battle against inflation remains ongoing.
Emerging Indicators
A subtle hint of another Fed rate hike within the next three months has emerged through options on the Secured Overnight Financing Rate (SOFR), the successor to the London interbank offered rate (Libor). Ben Emons, senior portfolio manager at NewEdge Wealth, notes this trend. Concurrently, Bill Dudley, former New York Fed president, cautioned in a Bloomberg News column about the adequacy of current interest-rate levels in sustaining U.S. growth.
Market Speculation
Opinions are divided within the market as discussions intensify around the potential need for a future rate hike. Jason Williams, global market strategist at Citigroup, had already broached this subject, linking it to the neutral rate of interest. Even a year ago, analysts at Credit Suisse foresaw that the Fed’s projected rate hikes might fall short in arresting inflationary pressures.
Impact of Possible Fed Rate Hike on Financial Markets
One immediate risk of a possible Fed rate hike to financial markets is that such a scenario isn’t currently priced into the 10-year Treasury yield BX:TMUBMUSD10Y against “crowded” equity positions, according to Emons.
Unnerving Stock Investors
Rising Treasury yields and higher-for-longer interest rates have a way of unnerving stock investors partly because the future cost of doing business also goes up. As of Tuesday afternoon, the 10-year rate was down by roughly four basis points at around 4.25%.
Uncertainty in the Market
The last time that the Fed’s meeting minutes were released was on Jan. 3, when the record of the central bank’s December gathering showed that officials hadn’t yet ruled out further rate hikes. Nonetheless, investors and traders started pricing in as many as six or seven quarter-point rate cuts for this year, more than policymakers had indicated would be appropriate.
Now that expectations have settled around at least three quarter-point Fed rate cuts by December, many investors are looking for fresh clues about how policymakers are likely to react to the most recent round of inflation data.
Concerns About Inflation
“What we could learn is how scared they are about inflation settling above 2% and how worried they might be about it not falling far enough, which would then delay the first rate cut and might take some of the air out of risk assets,” said economist Derek Tang of Monetary Policy Analytics in Washington.
Reaction Function of Fed Officials
“A lot of attention will be on Fed officials’ reaction function and what could make them cut after March,’’ Tang said. “The bar for hiking is very high” so policymakers ”are more likely to hold off on rate cuts or not cut at all for much longer than people think.”
Market Response
Financial markets returned from the three-day Presidents Day weekend in a risk-off mood on Tuesday, with all three major U.S. stock indexes DJIA SPX COMP lower in afternoon trading. This week’s marquee event is seen as Wednesday’s release of earnings results from Nvidia Corp. NVDA, -6.24%.
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