Societe Generale Analyst: Betting on a Fed rate cut in March is "chasing after shadows"

Despite the repeated warnings from Federal Reserve officials, market expectations for a rate cut in March remain strong, possibly due to an overreliance on historical experience.

According to data compiled by the media since 1980, on average, the Federal Reserve tends to ease policy about six months after the last rate hike. As the Federal Reserve is expected to remain on hold in January, extending its pause since July last year, this pause is expected to be longer than before.

Crédit Agricole pointed out that this, coupled with the continued slowdown in inflation, may prompt traders to be overly aggressive in pricing in rate cuts.

Subadra Rajappa, Head of US Rate Strategy at Société Générale, said:

Based on historical records, many believe that March seems appropriate for a policy shift. However, after Federal Reserve officials emphasized the risk of inflation rebounding, a rate cut in March seems premature. Société Générale believes that the Federal Reserve will cut rates in May.

Market "Confrontation" with the Federal Reserve Again

After a turbulent year, bond bulls are preparing to confront the Federal Reserve once again, betting that slowing economic growth and easing price pressures will force the Federal Reserve to start cutting rates soon. However, a measure of US bonds has fallen 1% this year after rising at the end of 2023, highlighting the risks accumulated in the market.

On Tuesday, after Federal Reserve Governor Waller called for caution in rate cuts, US bonds experienced their largest single-day decline in nearly two months, with the 10-year Treasury yield surging 12 basis points to 4.06%.

Swap contracts indicate that there is about a 70% chance of a 25 basis point rate cut at the March meeting. This is a decrease from over 80% last Friday, when some traders even began buying options to hedge against the risk of a 50 basis point rate cut.

In terms of overall positions, the market has largely ignored Waller's and other officials' warnings. Rajappa pointed out:

Those betting on a rate cut in March may be considering that the Federal Reserve's preferred inflation gauge, the US 6-month annualized core PCE, will drop to 2.6%. In addition, some in the market are concerned that if the pace of price increases continues to slow, real interest rates will become restrictive.

Prashant Newnaha, an interest rate strategist at TD Securities in Singapore, said that market rate cut expectations have been in overdrive since Federal Reserve Chairman Powell hinted at rate cuts in 2024 at the December policy meeting last year.

He expects the Federal Reserve to cut rates in May and added that the Federal Reserve may also want to raise rates early to maintain its reputation for independence, rather than starting rate cuts close to the US presidential election.