NEW YORK: Bond traders who have come to terms with the prospect of higher-for-longer interest rates through 2024 are looking towards this week’s US Federal Reserve (Fed) meeting for clues on how to game out 2025 and beyond.
Central bank officials will update their quarterly economic and interest rate projections – known as the dot plot – today.
As of March, officials were signalling three quarter-point cuts in 2024, but they’re expected to scale back that forecast in the face of a barrage of robust economic data, including strong May jobs growth.
Just hours before the Fed wraps up its two-day meeting, a fresh read on inflation will likely show prices running well ahead of the central bank’s comfort zone.
With the data giving the Fed little leeway to cut rates soon, investors are now debating whether future easing will amount to only a smallish tweak of policy into next year, as opposed to the series of reductions many had been expecting.
The difference may have big market consequences.
“We’re going to quickly turn the page to 2025,” said Kevin Flanagan, head of fixed income strategy at WisdomTree.
“Maybe we get one or two cuts this year, but how many are we going to get next year?” said Flanagan. “That will quickly become the centre of attention as we move into the second half of this year.”
The Fed has maintained a two-decade-high policy-rate range of 5.25% to 5.5% since July as the economy has held fairly strong, leaving two-year treasury yields hovering just below 5% and 10-year rates at around 4.5%.
While the market is pricing in less than two quarter-point rate cuts for this year, the general thinking has been that an easing cycle would kick in as the economy eventually cools.
On the margins, that’s starting to change.
Trades positioning for Fed policy rates staying elevated well into next year and 2026 have picked up via recent interest rate option trades.
Options traders are more hawkish than their counterparts in the swaps market, with March 2026 options targeting a Fed rate of roughly 5.75%, while swaps indicate a rate around 4% by that time.
Jean Boivin, head of the BlackRock Investment Institute said the bond market should be wary of anticipating that “a delayed easing cycle” will finally arrive given the likelihood that inflation averages above the Fed’s 2% target.
He said the bond market faces the prospect of “adjusting to the realisation that this is a shallow cutting cycle.”
The March dot plot saw the Fed moving the policy benchmark down to 4.6% in December and then to 3.9% by the end of 2025, according to the median forecast. It wouldn’t take many officials becoming more hawkish on their rate outlook to move the median projections higher.
Only a narrow majority signalled they expected to cut rates three times this year, with nearly half of policymakers preferring two or fewer reductions in 2024.
“It’s the dots that matter,” said David Robin, a strategist at TJM Institutional who’s been working in debt derivatives markets for decades.
“It’s either two moves or lower. And we would not at all be surprised to see at least two or three dots move to one or none for 2024.”
The resilience of the economy and loose financial conditions in spite of a 5% plus Fed funds rate has spurred chatter that policy isn’t truly restrictive and may need to rise. — Bloomberg