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Investors are further reducing their bets on U.S. Federal Reserve interest rate cuts this year, as strong economic data boosts hopes that the central bank will need to keep borrowing costs high to curb inflation.
Markets are pricing in two quarter-point rate cuts by the central bank in 2024, and only a 50 percent chance of a third, in a sharp reversal from earlier in the year when six and seven cuts were expected.
“Many customers ask us, 'Why are the feds going to cut rates?' It's really picked up in the last month or so,” said Evan Brown, portfolio manager and head of multi-asset strategy at UBS Asset Management. “With the economy this strong, policy is not as restrictive as the Fed thinks it is.”
Blockbuster jobs data on Friday added to growing optimism that the central bank may have to wait longer to ensure inflation is closer to its 2 percent target before cutting.
The central bank expects to cut its key interest rate from December to the current range of 5.25 to 5.5 percent, the equivalent of three quarterly basis point cuts this year.
After Friday's figures, Dallas Fed President Lori Logan said it was “too soon” to think about cutting rates, while Fed Governor Michelle Bowman said progress in reducing inflation had “stagnant of late.”
On Friday, bond fund firm Pimco cut its forecast to two cuts this year from three earlier.
“The majority of people I talk to don't think inflation will return to a sustainable 2 percent,” said John Day, a portfolio manager at Newton Investment Management.
U.S. Treasuries continued to sell off on Monday, with the interest rate-sensitive two-year Treasury yield rising 0.05 percentage points to 4.79 percent, its highest level since November. The benchmark 10-year Treasury yield rose 0.05 percentage points to 4.43 percent.
“Ten-year yields are high. I think they'll revisit 5 percent for the rest of the year,” said Laura Ramm, U.S. economist at FS Investments, who has suggested the Fed will make fewer cuts than it has signaled, or not at all.
“I don't think we'll see a program of rate cuts — say, quarterly — but more of a surgical, nip-and-tuck approach,” he added.
The shift in expectations will make it harder for other central banks to deliver multiple rate cuts this year without weakening their currencies against the dollar.
Investors also say that rising yields could derail US stocks. The S&P 500 index of blue-chip companies has risen more than 9 percent since the start of the year.
Equity investors have mostly played down the change in rate expectations, with strong economic data helping to ease fears that rates near current levels will hurt growth in the long run. The S&P rose 1.1 percent following Friday's jobs data, after falling earlier in the week.
“If the recent trend of higher energy and commodity prices continues, it has the potential to reactivate the 2022 financial market environment, which has been a bad time for bonds and risk assets,” said Mike Riddell, a bond fund portfolio manager. Manager at Alliance Global Investors.
Investors can get more visibility into the outlook for interest rates on Wednesday, when the US releases inflation data for March. Economists polled by Reuters had expected the headline annual rate to rise to 3.4 percent. Readings for January and February have already come in above analysts' forecasts.
A closely watched measure of long-term U.S. inflation expectations — known as the five-year, five-year-ahead break-even rate — pushed to 2.26 percent from 2.15 percent at the start of the year. Recent rise in oil prices. Brent crude, the international benchmark, was trading at $90 a barrel, down from $87 at the start of the month.
Some central bank officials have suggested that the recent rise in inflation may not last. Chairman Jay Powell said last week it was “too early to say whether the latest readings reflect more than a bump”.
Powell's comments make UBS's underlying case for two more cuts this year.
“Powell has been really adamant that growth and a good labor market is not a reason to avoid cutting rates if inflation comes down. So until he makes that kind of reaction, we should still keep rate cuts in our forecast,” Brown said.
