Market no longer overly optimistic, traders reduce bets on Fed rate cut in March

Zhitong App noticed that bond traders have abandoned their bets on a rate cut by the Federal Reserve in March, pushing up the swap rates to a level consistent with only about a 50% chance of a 25 basis point reduction in the federal funds target rate in the first quarter.

At various points in the past month, they have almost completely priced out the move, in response to economic data and revisions by Goldman Sachs and Barclays to their forecasts for rate cuts starting in March.

The market's implied probability of a rate cut in March has seen the latest change, partly due to stronger-than-expected U.S. retail sales data for December. This also reflects selling pressure on short-dated UK bonds, as hotter-than-expected domestic inflation data prompted traders to expect the Bank of England to refrain from easing policy this year.

Tracy Chen, portfolio manager at Brandywine Global Investment Management, said, "The market has priced in too aggressively the magnitude and timing of rate cuts." She added that the Fed is more likely to cut rates for the first time in June rather than March. "The risk here is that if we don't have a soft landing, inflation will become stickier. Today's retail data shows that consumers still have resilience."

Traders continue to expect the Fed to start unwinding its aggressive tightening policy this year, which raised the federal funds rate ceiling from 0.25% in early 2022 to 5.5% in July 2023. But they expect a total of about 140 basis points of cuts, below the recent peak of nearly 175 basis points.

The reassessment of the possible path of U.S. monetary policy has pushed up yields on U.S. Treasuries, with the two-year Treasury yield rising 15 basis points to 4.37%. The two-year UK government bond yield rose 21 basis points to its highest level since mid-December.

Longer-dated bond yields have risen less, dampening demand for the auction of 20-year bonds. The issuance produced a higher-than-expected yield of 4.423%, and dealers received their largest share since November 2021, as investors held fewer stocks.

Retail sales in December grew by 0.6%, the strongest pace in three months. The indicator used to calculate GDP grew by 0.8%, the largest increase since July last year. The Beige Book regional business contacts survey released by the Fed on Wednesday evening showed that strong consumer spending offset weakness in manufacturing.

Marilyn Watson, head of global fundamental fixed income strategy at BlackRock, said, "I don't think the current data is enough to give the Fed confidence to cut rates in the near term." "I think the timing of rate cuts this year may be later than March."