Investors reduce bets on interest rate cuts in 2024


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Investors have scaled back their wagers on interest rate cuts this year after economic data and warnings from central bank officials poured cold water on a market that had got “way ahead of itself” late last year. 

Traders in swaps markets have moved to bet on five or six rather than six or seven quarter point rate cuts by the Federal Reserve over the course of the year. They are now pricing in a 75 per cent chance of the first cut in March, having fully priced in such a move at the end of last year.

The less sanguine view on rate cuts comes as stronger than expected US jobs data this week weakened the case for the Fed to start cutting rates soon. Minutes from the Fed’s last policy meeting published on Wednesday painted a more hawkish picture than chair Jay Powell’s comments in the accompanying press conference.

“The latest jobs report is the one piece of data we were missing to see markets show some moderation,” said Florian Ielpo, head of macro at Lombard Odier, adding that after the Fed’s latest monetary policy meeting “the rate cut pricing went way ahead of itself, far beyond what the Fed was communicating”. 

In the final weeks of 2023, investors ramped up bets that central banks on both sides of the Atlantic would deliver rapid rate cuts this year, fuelling the biggest two-month global bond rally for several years.

That came on the heels of encouraging inflation data and an unexpectedly dovish stance from the Fed, which in December published new forecasts that showed its officials pointing to 75 basis points worth of cuts next year.

Column chart of Rate cuts priced for 2024 (percentage points) showing Markets scale back rate cut bets

“Labour markets remain tight, pay settlements remain strong, inflationary pressures are rising on Middle East tensions, whilst financial conditions continue to ease,” said Craig Inches, head of rates at Royal London Asset Management, who thinks it’s unlikely the Fed would deliver close to six cuts this year.

“This is quite a headache for central banks and, with hardly anyone predicting a large scale global recession, I find it hard to fathom why rates will be cut so quickly,” he added.

Investors in Europe have followed the US in pushing bond prices lower as they have scaled back pricing for European Central Bank and Bank of England rate cuts this year.

This view was boosted by data showing eurozone inflation rose to 2.9 per cent in December, reversing six months of consecutive falls, while upward revisions to business activity readings this week suggested the economy was stronger than previously thought. That added to questions over how soon the ECB will start cutting rates.

“Given the latest PMI and inflation data, I think that the ECB will cut at their June meeting at the earliest,” said Tomasz Wieladek, chief European economist at T Rowe Price.

Markets are betting that the ECB will deliver 1.46 percentage points of rate cuts this year, down from 1.64 at the start of the week, with the probability of the first cut in March falling to around a half.

Investors have also had a rethink about the path forward for the BoE, pricing that UK interest rates will fall to 4 per cent by the end of the year, down from a bet of 3.5 per cent at the end of last year. Business activity readings for the UK were also revised up this week.

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