Traders continue to readjust their expectations for how much higher U.S. interest rates could climb this year, and are now putting a very slim chance on an almost 6% fed-funds rate in five months.
Though fed-funds futures reflect the overwhelming likelihood that rates will come in between ranges no higher than 5.75% by July, traders are pricing in a 4% chance that the fed-funds rate target could reach 5.75% to 6%. That’s compared with a 2% chance on Friday and zero chance last month. Such a level would imply that, if the Federal Reserve hikes rates at each of its next four meetings, one of those moves would be bigger than a quarter-of-a-percentage-point increment. The fed-funds rate target currently sits between 4.5% and 4.75%.
While the prospect of higher-for-longer interest rates has been on the minds of traders and investors for some time, it’s taken a while for the reality of such a scenario to sink in.
As of Tuesday afternoon, all three major indexes
were down, led by a 1.9% drop in the growth-heavy Nasdaq
which had managed to keep rallying last week despite a trend of rising Treasury yields. Bonds aggressively sold off on Tuesday — sending the 1-year T-bill rate BX:TMUBMUSD01Y toward its highest level in 22 years, at around 5.05%, according to Tradeweb.
Read: Buy the stock-market dip? Why ‘cash’ yielding more than it has since 2007 could be king.
Meanwhile, gold prices extended their slide and the ICE U.S. Dollar Index
a measure of the currency against a basket of six major rivals, rose almost 0.3%.
“Markets are still digesting last week’s data and commentary from the Fed and European PMI data this morning looks a bit better as the resilience of the global economy continues to show up. Stubbornly high inflation takes rate cuts off the table,” said Tom Nakamura, a portfolio manager and currency strategist at AGF Investments in Toronto, which oversaw C$42.1 billion ($31.2 billion) as of January.
Tuesday’s moves reflect “a repricing of central bank hikes and cuts, with an increased chance of a higher peak in the fed-funds rate and less likelihood of cuts in the second half,” Nakamura said via phone.
The outside risk of a peak 6% fed-funds rate target has been around for almost a year, but investors and traders have hesitated to put much weight on it. The last time interest rates were that high was January 2001.
The Fed’s December Survey of Economic Projections, which plots out the rate forecasts of individual policy makers, reflected expectations for the fed-funds rate to peak just above 5% this year. But a run of strong economic data has led to speculation that policy makers will push their peak-rate forecasts higher when the so-called dot plot is updated in March.
In a note released Monday, Dominique Dwor-Frecaut of research provider Macro Hive stuck by a call she made a year ago that the Fed could get to 8% because “we’re stuck in a high inflation regime,” monetary policy is still too loose, and the Fed “could fall further behind the curve.”
According to AGF’s Nakamura, “the path to 6% is easier to get to later this year because we’re not that far away from there, and is probably something that’s problematic for equity markets but can be handled OK. For the Fed to get to 8% would require a pretty big resurgence of inflation, and would most likely lead to a repeat of last year,” which produced a dismal performance in both stocks and bonds.
See: Will recession slam the stock market? Here are 3 ‘landing’ scenarios as Fed keeps up the inflation fight.