Rates Traders Pare Back Bets on U.S. Recession, End to Fed Hikes

(Bloomberg) -- Investors are rethinking the timing of the next U.S. recession, according to the Eurodollar market.

The spread between December 2019 and December 2020 Eurodollar contracts has risen back above zero, suggesting short-end traders have pulled back from expecting a possible interest-rate cut after next year. The move suggests traders now see a hike as more likely than a cut in 2020.

Rates Traders Pare Back Bets on U.S. Recession, End to Fed Hikes

Trading activity in the spread contract has surged this week, with volume reaching the second most on record on Tuesday.

The drop into negative territory in July came as investors began to price in the possibility that the U.S. economic expansion would come to an end, and the Fed would call a halt to its tighter monetary policy. The reversal comes as the Fed raised rates for a third time this year, cemented expectations for a fourth and reaffirmed that a strong economy will probably warrant further gradual increases well into 2019.

“With the spread again positive, the market has very modestly inflected toward the potential for another hike in 2020 on a re-gearing of U.S. economic bullishness,” Nomura Holdings Inc. strategist Charlie McElligott wrote in a note to clients Wednesday. “This is telling us something powerful about the market’s accelerating positive sentiment on U.S. economic growth trajectory.”

Investors are pushing back their expectations on the timing of the next recession, he said.

Still, while the Fed’s statement made hawkish noises on their view of the economy, there were also some potential signals for doves. The statement omitted a reference to “accommodative” policy and a few officials downgraded their 2020 “dots,” or rate expectations, for that year.

While calling the economy strong and financial vulnerabilities moderate, Chairman Jerome Powell also said the central bank is hearing a “rising chorus” of concern about tariffs and the U.S.’s turn toward protectionist trade policies.

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