Traders Now See 50% Chance of 0.25 Cut in March
Expectations for an aggressive 0.5 percentage point interest rate cut by the Federal Reserve at their March policy meeting have cooled this week, according to futures market pricing and comments from Fed officials.
Traders are now pricing in just a 50% chance of a smaller, 0.25 percentage point cut in March, down from 70% odds seen last week. The shift follows comments from several Fed policymakers expressing reluctance to cut rates in the near future given still solid economic data.
“The economy might be too hot for a March rate cut,” said Tim Duy, chief U.S. economist at SGH Macro Advisors. “The data just isn’t cooperating with the bond market’s aggressive pricing of rate cuts next quarter.”
Resilient Data Challenges Rate Cut Bets
The U.S. economy has proven surprisingly resilient in recent months, challenging the narrative behind traders’ bets on imminent Fed easing.
Robust labor market data, healthy retail sales growth, and stabilizing inflation have led economists and investors to temper expectations for interest rate cuts starting as early as March.
“US resilience suggests the Fed will wait until at least May before commencing their mid-cycle mini-easing plan,” wrote analysts at NatWest Markets.
Just a week ago, futures contracts tied to Fed policy expectations were pricing in a 30% chance of a half percentage point cut by March. But a string of solid economic reports has prompted rethinking around the timing of cuts.
“It was the data, it always is,” said global macro strategist Vincent Deluard of StoneX. “The problem with taking a binary bet on an imminent recession is that you implicitly bet against the most adaptive system mankind has created – the US economy.”
Fed Pushback Against Market Expectations
In addition to the resilient data, Fed policymakers themselves have provided substantial pushback against market expectations of imminent policy easing.
Regional Fed presidents Raphael Bostic, Loretta Mester and James Bullard have all made comments this week suggesting rates may need to remain restrictive for longer to ensure inflation continues trending down towards the central bank’s 2% target.
“The Fed’s message is starting to get through to Wall Street,” said Victor Jones, market strategist at Investors Business Daily. “Traders are paring back expectations for quick rate cuts even as recession risks remain.”
Policy Path Remains Data Dependent
Most economists expect the Fed will need to cut rates before the end of 2024 to counteract slower economic growth and contain corporate credit risks. But the timing and magnitude of cuts remains highly uncertain and dependent on the flow of data.
“It’s still a coin toss whether we’ll get a small cut in March or they’ll wait until May,” said Roberto Perli, head of global policy research at Piper Sandler.
According to Perli, the strength of February’s jobs report and January inflation data will prove pivotal in determining whether the Fed pulls the trigger in March.
“If we continue to see moderating price pressures alongside solid job gains, that buys them more time,” said Perli. “But one bad print on either could force their hand.”
Financial markets have pulled back some of their expectations for Fed rate cuts in reaction to the shift in tone amongst policymakers.
Stocks fell, bond yields rose, and the U.S. dollar strengthened versus major currencies on Jan 17th and 18th as traders marked down the prospect of cuts in March and the potential for an eventual Fed funds rate below 4.5%.
|Jan 17 Close
|Jan 18 Close
Outlook Remains Murky
Considerable uncertainty remains around the growth and inflation trajectory which will dictate future Fed moves.
Continued moderation in price pressures alongside steady consumer demand could buy the Fed more time. But most economists think the central bank will still need to cut rates at least twice in 2024 to try and engineer a soft landing.
“It’s still a race between the Fed cuts and a recession,” concluded Michael Pento, president of Pento Portfolio Strategies. “And while the economy may avoid contracting in the first half, I still see a consumer retrenchment by year-end as savings dry up.”
So while markets have scaled back expectations for March specifically, the policy path remains far from clear. Traders will be closely eyeing every piece of economic data for signals of turning points in growth and inflation as the Fed seeks to strike the right balance.
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