With the U.S. economy and inflation proving to be far more durable than many expected, traders have been pushing up the odds of ongoing rate hikes by the Federal Reserve through June — a scenario that seemed unlikely a few weeks ago.
Earlier this month, the Fed’s main benchmark rate target had been seen as peaking at around 4.9%. On Wednesday and Thursday, though, traders were factoring in a 52% likelihood that the fed-funds rate target could rise to between 5.25% and 5.5%, or even higher, by June — levels not seen in close to two decades or more. That’s after factoring in three more quarter-of-a-percentage-point rate hikes at each of the Fed’s next three meetings in March, May and June, though traders also saw growing chances of a bigger half-point increment being delivered next month.
Financial markets are in the process of readjusting expectations for how high U.S. interest rates could go, after a string of unexpectedly strong U.S. data that includes Thursday’s wholesale-prices report for January, Wednesday’s retail-sales figures, the consumer-price index report from Tuesday, and a blowout jobs report two weeks ago.
Traders have not only moved closer to the Fed’s own estimate for a 5.1% fed-funds rate this year, but some are now going beyond that. The possibility of a bigger, half-point rate Fed hike next month jumped to 15% on Thursday from 12% a day ago, and the prospect of a 6% fed-funds rate by September is on the map, though seen as an extremely slim 1.1% possibility, according to the CME FedWatch Tool. The fed-funds rate currently sits between 4.5% and 4.75%.
“Investors who see the strength in the labor market and consumer spending are now sort of wondering if the economy is really slowing at all. And if it’s not slowing, the Fed will probably keep hiking much further into 2023 than we assumed a few weeks ago,” said Tom Graff, head of investments at Baltimore-based Facet Wealth, which oversees $1.9 billion. “We don’t think something like a 6% fed-funds rate is very likely, but it’s a possibility to consider.”
Until recently, investors and traders had mostly been expecting rate hikes to come to an end soon. This was the case even after though policy makers had already used their December Summary of Economic Projections to point out the need for a 5.1% fed-funds rate in 2023. Fed Chairman Jerome Powell, at his news conference on Feb. 1, also said the Fed needs to see “substantially more evidence” that price pressures are evaporating to be comfortable inflation is actually declining.
Fresh comments by another Fed official on Thursday lent more weight to the possibility that policy makers might need to turn aggressive once again with the size of their next round of rate hikes: Cleveland Fed President Loretta Mester said she saw a “compelling” case for a half-point hike at the central bank’s Jan. 31-Feb. 1 meeting, where policy makers hiked by a smaller, quarter-point increment instead.
This week’s readjustments in rate expectations were seen as potentially setting up financial markets for further rounds of tumult. On Thursday, all three major U.S. stock indexes SPX,
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