Forget Fed Hikes, Traders Are Now Fully Pricing a Cut by April 2020

(Bloomberg) -- Bond traders are showing little sign of stepping back from their fight with the Federal Reserve over the path of interest rates and the market is now positioned for cuts on the horizon.

Just over a month ago the market was pointing to a quarter-point hike in 2019, but it’s now factoring in a more than 50 percent chance of a reduction this year. That’s in stark contrast to the median projection of two increases projected by Fed officials last month. On top of that, traders are now fully pricing in a cut by April 2020.

The rate on the June 2020 U.S. dollar overnight index swap, which was close to 3 percent less than two months ago, dropped as low as 2.04 percent on Thursday -- suggesting a benchmark rate more than 30 basis points below the current effective fed funds rate by the middle of 2020.

Forget Fed Hikes, Traders Are Now Fully Pricing a Cut by April 2020

The latest move was fueled by a global slide in riskier assets and data showing the steepest drop in U.S. manufacturing activity since October 2008. Add to that a ‘flash crash’ move in the yen, gridlock over the U.S. government shutdown and a warning from iPhone maker Apple Inc., and traders have plenty of reasons to reappraise the Fed’s path.

The swiftness of the recent shift in rates markets has raised some eyebrows, however. Boris Rjavinski, a strategist at Wells Fargo & Co., says that Chairman Jerome Powell and other members of the Federal Open Market Committee are still likely to press on with hikes in March and September and that the market will shift back to pricing in tightening.

Determined Fed?

“If you read the statements from the December FOMC and particularly if you listen to what Chairman Powell said in the press conference, they’re determined to fulfill their mandate,” Rjavinski said. “You can’t deny that by historical measures fund rates are still pretty low.”

He said markets have been too aggressive in pricing out rate hikes in response to tightening financial conditions and political uncertainty as the government shutdown drags on.

“Political risk is something that’s very hard for markets to handicap,” he said. “It’s very hard to trade and that’s what creates this mood of maybe the Fed is done.”

One Fed official who does appear to be advocating a less aggressive path is Robert Kaplan. The head of the Dallas Fed said Thursday that the U.S. central bank should put interest rates on hold as it waits to see how uncertainties play out.

©2019 Bloomberg L.P.