Investors have sharply ratcheted up their bets that the US Federal Reserve will deliver big rate cuts this year, reflecting uncertainty over monetary policy amid turmoil in global banks and data showing a slowdown in inflation.
Pricing in futures markets suggests that the Fed will cut rates in June by either 0.25 or 0.5 percentage points, and deliver further cuts to bring the overall rate down to 3.6 per cent. That would represent a reduction of slightly more than 1 percentage point from the 4.7 per cent peak that is expected to be hit in May.
Most bond traders now expect the Fed will not implement a rate rise at its meeting next week, though some still see a chance of a quarter-point increase, according to pricing in futures markets.
The changing expectations led to frenzied trading with some market participants reporting that the volatility had prompted CME to briefly halt trading in fed fund and Sofr futures on Wednesday morning.
“There is a circuit breaker that gets tripped if those futures move more than 50 basis points and that happened this morning,” said Tom Simons, money market economist at Jefferies.
CME did not respond to a request for comment.
The two-year Treasury yield, which is more sensitive to interest rate expectations, fell 0.47 percentage points on Wednesday morning. It has fallen from more than 5 per cent last week to 3.76 per cent on Wednesday in moves not seen since the late 1980s.
The 10-year yield fell 0.21 percentage points to 3.4 per cent.
“Some market participants were looking for the Fed to keep hiking until something broke. The question now is, was this it?” said Michael de Pass, global head of linear rates trading at Citadel Securities, referring to the bank sell-off.
While some of the shift in futures markets can be explained by changing expectations for Fed policy, much of it is also likely to reflect the unwinding of leveraged positions that had been building up since the start of the year.
“Speculators had been the shortest on bonds they had been in some time,” said Simons. “Now we’ve had a risk event and it has been a scramble to cover those positions,” he added.
However, the move reflects uncertainty about the path for Fed policy, rather than cemented expectations for cuts.
Expectations first began to shift after concerns mounted over the fate of Silicon Valley Bank late last week. They shifted further on Wednesday after Credit Suisse said its largest shareholder would not provide the bank with more capital.
Meanwhile, the US reported that producer prices fell 0.1 per cent in February, versus expectations for a small increase. Wednesday’s PPI report tempered the news from Tuesday that the consumer price index had cooled, but by slightly less than forecast.
“If we take a step back, the Fed has done a fair amount in terms of the hiking cycle. And you look at when the hiking cycle started, we’re now at the point where you’d really expect the effects of the hikes to kick in in earnest,” said de Pass.