Investors who had been expecting the Federal Reserve to cut interest rates this year are now reconsidering their bets after a string of strong US economic data pointing towards persistent inflation. Initially, futures markets indicated that the Fed would cut rates at least twice by the end of the year, but recent data has caused a shift in expectations. The US reported that consumer prices in January were higher than anticipated, with housing costs playing a significant role in boosting inflation. Additionally, US retail sales saw a 3% increase in January, well above the predicted 1.8% rise. These positive economic indicators have caused investors to align more closely with the Fed’s message that rates will not be lowered until at least 2024.
Despite hopes for rate cuts, the US employment report for January revealed a strong job market, leading the Fed to raise its main policy rate by 0.25 percentage points in February. Prior to this, futures markets suggested that the Fed’s benchmark interest rate would peak at 4.9% in the second quarter before dropping to around 4.4% by the end of the year, indicating the possibility of two rate cuts of 0.25 percentage points each. However, current pricing indicates expectations for rate hikes in March and May, with a peak at 5.25% before a potential decrease towards the end of 2023. This shift in rate expectations has also been accompanied by changes in inflation forecasts, with the one-year break-even inflation rate rising from 2.1% to 2.9%.
Market expectations have now aligned more closely with the Fed’s own forecasts from December, which predicted interest rates to end the year at around 5.1% and inflation at 3.5% by the end of 2023. Analysts believe that the strong economic data, particularly in terms of job growth and inflation, have set a tone for the market that suggests a scenario in which inflation is likely to remain high. These developments have led to a change in investor sentiment, with a shift towards a more realistic outlook on interest rates and inflation in the coming years. Despite initial hopes for rate cuts, the US economy’s resilience and strong performance have influenced investors to revise their expectations regarding monetary policy moving forward.
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