The once unthinkable scenario of the Fed not cutting interest rates in 2024 is now giving way to the alternative possibility that the Fed will slightly raise interest rates by 25 basis points in June.
This latest scenario can be seen in the Atlanta Fed's market probability tracker, where as of this week, secured overnight financing rate (SOFR) options reflect a roughly 3.6% chance of a 25 basis point rate hike in June.
Options traders have been discussing rate hike scenarios for months, and federal funds futures briefly priced in a rate hike on Thursday after overnight jobless claims data showed no increase in layoffs and an index of Philadelphia-area factories reflected improved economic conditions. However, traders remain reluctant to fully price in the possibility of a Fed rate hike, preferring to maintain that the Fed is likely to remain on hold until September.
“We’re seeing more and more clients talking about rate hikes,” said Scott Buchta, head of fixed income strategy at Brean Capital in Tennessee. “In terms of the number of rate cuts the Fed is going to have, more people are now looking at one or zero rate cuts in 2024.”
The bar for the Fed to raise rates is likely to be high, the strategist said, adding that his firm sees a 60% chance that the U.S. economy can continue to grow, inflation can moderate and policymakers can cut rates twice this year and three more times in 2025.
Scott Buchta said people are starting to turn to the "inertia trade," in which U.S. inflation remains sticky, the economy remains stable and the Federal Reserve remains on hold, prompting greater interest in short-term floating-rate assets.
On Thursday, FOMC permanent voting member and New York Fed President Williams said that "raising interest rates is not the basic situation", but he did not rule out the possibility that the Fed's next move might be to raise interest rates. He said that if the data shows that it is necessary to raise interest rates to achieve the Fed's goals, policymakers will obviously be willing to do so.
“Williams didn’t argue against raising rates,” said Derek Tang, an economist at Monetary Policy Analytics in Washington. The FOMC, which sets policy, “still has a lot of room to remove expectations of rate cuts, which will tighten financial conditions.” “I think they are nervous about raising rates again, and I hope they can control recession risks,” Tang said by phone. “But they are walking a tightrope, and the room for error is much smaller now than it was a few months ago.”
On Thursday, the 1-year inflation swap was 2.72% (an inflation measure based on market expectations), higher than the level in January, but still far below the level of about 6% during 2022. According to foreign media data, the policy-sensitive 2-year U.S. Treasury yield rose to nearly 5%, while most major U.S. stock indexes closed lower.
Robert Daly, director of fixed income at Glenmede Investment Management in Philadelphia, which manages more than $4.5 billion in assets, said the focus now is on "what does higher rates for longer mean, and that starts to have important implications for risk asset valuations."
“There hasn’t been a lot of talk about raising rates, but if we don’t see a perfect disinflation scenario unfold, that discussion could quickly pick up,” Daly said by phone on Thursday.
The article is forwarded from: Jinshi Data