Traders Brace for Possibility of Five Fed Rate Hikes This Year
Traders Ramp Up Bets to See Five Federal Reserve Hikes This Year
(Bloomberg) -- Traders are boosting bets for higher borrowing costs, with money markets now expecting almost five interest-rate increases from the Federal Reserve this year and four from the Bank of England.
Investors are also speculating whether Fed Chair Jerome Powell will front-load hikes by potentially making a rare 50-basis-point move in March, after he struck a hawkish tone at this week’s meeting. The wagers have rippled through markets, driving down short-dated bonds and sending curves toward their flattest since 2020. CME open interest data following Wednesday’s selloff showed a build-up of new short positions across the Treasuries curve as yields surged higher.
The pace of rate hikes being indicated by front-end markets has been accompanied by a rebound in longer-dated bonds, as investors consider the potential the Fed is willing to risk stifling growth to cool inflation. Traders are pricing around 30 basis points into the March meeting, suggesting some bets on a half-point hike then. They are certain four hikes will come by year’s end and have ramped up bets on a fifth one.
U.S. gross domestic product growth figures for the last quarter of 2021 came in stronger than expected, at an annualized pace of 6.9%, although there was little reaction in rates pricing given the market has already taken on a hawkish tilt in the wake of the Fed meeting.
Shortly after Wednesday’s Fed policy announcement, Nomura Holdings Inc. changed its forecast for Federal Reserve interest-rate hikes, with the bank now expecting a 50 basis-point increase in March. Money markets are currently pricing a half point of tightening by the May policy meeting. On Thursday, the three-month dollar Libor rate fixed over 2 basis points higher, the largest rise since November 2020.
“People are getting serious about a 50-basis-point hike,” said Rishi Mishra, an analyst at Futures First.
The tone of Powell’s press conference leaves no doubt that price stability takes precedence over other policy goals, meaning there’s even an upside risk of six hikes, Bloomberg Intelligence’s Anna Wong wrote in a note.
‘Too Low’
“My biggest disagreement with market pricing though is in the context of a terminal rate in the cycle, where the market discounts rates topping at 2%,” said Mark Dowding, CIO of BlueBay Asset Management. “I think this is 100 basis points too low and see rates getting to 3% in 2024.”
The on-off bets on faster policy tightening in recent months have spurred greater volatility across markets. U.K. bonds took the biggest hit Thursday, with two-year yields climbing to the highest since 2011. The Treasury curve has flattened this week, with two-year yields rising almost 20 basis points, far outpacing the five basis point increase in 10-year yields.
The rate-hike fever spread, with investors increasing bets the Reserve Bank of Australia will hike in May, well before the late-2023 lift-off policy makers had flagged as the earliest likely timetable. The RBA is widely expected to scrap its quantitative easing program when it meets Feb. 1.
In Europe, traders are betting on a 25-basis-point move by the Bank of England next week to 0.5%. Money markets see the bank rate at 1% by June and then climbing to almost 1.5% by December. That wasn’t enough to prop up the pound against a resurgent dollar.
The European Central Bank, which has consistently sounded more dovish than its major peers, is now expected to hike its deposit rate by 10 basis points to minus 0.4% by September, from October previously. Policy makers led by Christine Lagarde next meet on Feb. 3.
“It will be really interesting to see if Lagarde will push back on 2022 pricing -- the question is if she can convince markets,” said Piet Christiansen, chief strategist at Danske Bank A/S. “I think she will still say that uncertainty is high and it is highly unlikely to raise rates this year. In this market, it’s not time for high conviction calls on central bank pricing.”
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