Traders bet Fed rate hikes are over after benign US inflation report

New York – A normal day for markets became something extraordinary after a hotly anticipated report on US inflation gave traders the green-light to declare that the US Federal Reserve’s most aggressive interest rate hiking cycle in decades is over.

Yields on rate-sensitive two-year notes slumped as much as 23 basis points to 4.81 per cent, as investors marked down the odds of another rate increase to almost nil.

Meanwhile, the benchmark 10-year rate slid about 19 basis points to 4.45 per cent, and traders boosted their bets on the Fed slashing rates in 2024 to price in more than half a percentage point of cuts by July.

Traders in the options market went one step further, piling into wagers that stand to benefit from cuts as soon as March.

In US stock markets, the Dow Jones Industrial Average rallied 1.4 per cent, while the broad-based S&P 500 Index jumped 1.9 per cent and the tech-rich Nasdaq Composite Index surged 2.4 per cent.

“There’s been a sea change in investors’ perceptions of where the Fed is headed with policy,” said Stifel Nicolaus & Co strategist Chris Ahrens. “Not only do they see the Fed as done, but they are pricing in two cuts by the middle of next year.”

The huge rally in Treasuries – which saw some of the biggest daily moves since March’s banking crisis – marks a sharp U-turn from less than a month ago, when 10-year yields surpassed 5 per cent for the first time since 2007.

While the recovery has been choppy, the bond market recovery has gained ground since the Fed left its benchmark policy rate unchanged earlier in November.

That, and the improving inflationary outlook, is prompting a shake out on Wall Street and beyond.

ARK Investment Management head Cathie Wood told Bloomberg TV on Tuesday that deflation is already under way in the United States across industries.

Meanwhile, Bank of America economists are no longer expecting the Fed to raise interest rates again.

Yet some are already cautioning that the Fed risks denting its reputation if it moves towards cuts too quickly.

Citadel founder Ken Griffin said on Tuesday that US central bankers “risk losing credibility around their commitment to a 2 per cent inflation target” if they cut too soon.

Swap contracts used to hedge future Fed actions see the US central bank slashing rates by a full percentage point by the end of 2024. Yet inflation is still above the Fed’s target.

Inflation data

The US consumer price index (CPI) was unchanged in October versus a median estimate of a 0.1 per cent increase in Bloomberg’s survey of economists.

Core CPI, which excludes food and energy, increased 0.2 per cent compared with the 0.3 per cent median estimate.

The year-on-year rate slowed to 4 per cent against an estimate of 4.1 per cent.

“I still think that inflation will take time to come down and that will leave the Fed on hold longer than you typically see during a cycle,” said Ms Erin Browne, the portfolio manager for multi-asset strategies at Pacific Investment Management Co (Pimco).

“The Fed is not going to take its applause and take a bow with just one data print”, and will wait “to make sure that the data continues to confirm that inflation will fall”, she said.

Overall, Pimco is bullish on bonds, sticking with a 2024 forecast they and others had for 2023 that did not pan out.

Hope is building now that with the fall in yields in recent weeks, bond investors could avoid what looked like a sure thing just a few months ago – a third straight year of losses in Treasuries.

A broad index of Treasuries was down 1.2 per cent in 2023 as at Nov 13, after losing an unprecedented 12.5 per cent in 2022 and 2.3 per cent in 2021.

“The bar for further rate hikes is getting higher and higher at this point,” Wells Fargo & Co chief economist Jay Bryson said. BLOOMBERG