Fed Whiplash Leaves Traders Betting Next Policy Move Will Be Cut
Move to tighten policy was already seen as long shot, but Fed’s new tone casts doubt on prospects of rate heading higher at all.
(Bloomberg) -- Federal Reserve Chairman Jerome Powell’s first press conference of 2019 left market expectations for an interest-rate hike this year hanging by a thread, and raised the chances of a cut in 2020.
A move to tighten policy in March was already seen as a long shot, but the Fed’s tone on Wednesday cast doubt on the prospects of any rate increase this year, after nine hikes since 2015.
A stronger focus on risks to the global outlook, the Fed’s emphasis on tighter financial conditions and Powell’s comments pushed two- and five-year Treasury yields to the lowest since mid-January. Shorter maturities led gains, steepening the yield curve. The spread between five- and 30-year yields was 55 basis points in European trading, after increasing to as much as 57 basis points Wednesday, the widest since last February.
Powell is “definitely listening to markets,” Jim Bianco, founder of Bianco Research LLC, told Bloomberg Television. The next move “will probably be a cut at this point, probably later this year, like December or the first quarter of 2020.”
Another sign of waning prospects for a rate hike this year was the drop in near-dated implied volatility on swaptions -- options on U.S. interest-rate swaps -- which dropped to the lowest since November for one- to two-year contracts.
“The market is very aggressively discounting any positive outcomes this year” in areas such as domestic growth, trade and the global economy, said Ed Al-Hussainy, a senior interest-rate strategist at Columbia Threadneedle.
The Fed’s tone toward its policy rate and balance sheet is significant, he said. “The language and the markers they put down all point to a very elevated probability that the December hike was the last hike in the cycle.”
Market watchers were surprised by the Fed’s latest signals on its balance-sheet unwind, which suggests the central bank is closer to completion than previously expected. For traders, the Fed’s line that it’s “prepared to adjust any of the details for completing balance sheet normalization” confirmed a shift in a policy unwind that’s roiled markets.
“I am recovering from monetary-policy whiplash,” Omair Sharif, an economist at Societe Generale, wrote. “The bar for hiking rates even once in 2019 is extremely high.”
Rates traders cut what little positioning remained for a hike in 2019, and are gaining confidence in a 2020 easing.
JPMorgan Chase & Co. strategists still expect the central bank to resume tightening after mid-2019, but recommend that investors unwind their bets for the U.S. five- to 30-year yield curve to flatten. Capital Economics senior economist Michael Pearce sees a rate increase coming sooner -- in the first half itself -- based on solid economic data and easier financial conditions.
“But we would place far more emphasis on our forecast for a sharp slowdown in economic growth further ahead, which we expect will force the Fed to cut rates by 75bp in 2020,” he said in a report after Powell’s press conference.
--With assistance from Edward Bolingbroke, Benjamin Purvis, Stephen Spratt and Anna Edwards.
To contact the reporters on this story: Emily Barrett in New York at ebarrett25@bloomberg.net;John Ainger in London at jainger@bloomberg.net
To contact the editors responsible for this story: Benjamin Purvis at bpurvis@bloomberg.net, Mark Tannenbaum, Anil Varma
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