Market participants don’t believe Fed officials’ assertions that the central bank will maintain its course and continue raising rates. Kate Duguid and Colby Smith report in the Financial Times:
Investors and Federal Reserve officials are at odds over the path of US interest rates this year, widening a gap between the forecasts of policymakers and market expectations.
Markets suggest the central bank will back off and reverse its months-long campaign to raise interest rates, the most aggressive since the 1980s. Senior Fed officials insist it will hold firm.
The divergence reflects beliefs about future inflation, which has cooled in recent months but remains high by historical standards. “There is a very clear disconnect and it is a disconnect about inflation,” said Priya Misra, head of rates strategy at TD Securities.
Most Fed officials have endorsed raising the benchmark federal funds rate above 5 per cent and maintaining that level until at least the end of the year in order to cool the economy enough to get inflation under control.
Futures markets indicate the Fed will stop short, capping its policy rate between 4.75 per cent and 5 per cent, before implementing half of a percentage point’s worth of interest rate cuts from peak levels by December. By the end of 2024 the fed funds rate will fall as low as 2.8 per cent, according to market prices, roughly a full percentage point below what Fed officials projected in December.
Bets on lower rates have proliferated as investors have lowered their inflation expectations. On Friday the one-year US inflation swap, a derivatives contract that reflects inflation expectations for a year from now, was 1.77 per cent, its lowest level in more than two years, according to Refinitiv.
Another market measure, the so-called one-year break-even inflation rate, currently stands at 2 per cent.
Ajay Rajadhyaksha, global chair of research at Barclays, said: “The market does genuinely believe that inflation will come down more quickly than the Fed expects it to. The Fed believes that it is very difficult for inflation to come down without the labour market softening, but the market isn’t convinced.”
Fed officials have sought to curb speculation that they will soon change course even though some favour slowing the rate of increase to a quarter of a percentage point at their next meeting, which ends on February 1.
Read more here.