Investors lose hope of rapid US interest rate cuts this year

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Investors are giving up hope that the US Federal Reserve will sharply cut interest rates this year, after a blockbuster jobs report on Friday boosted conviction that the central bank needs to keep borrowing costs high to cool inflation.

Markets are pricing in two quarter-point rate cuts by the Fed in 2024 and only a 50 per cent likelihood of a third, in a drastic reversal from the start of the year when between six and seven cuts were expected.

“The vast majority of people I speak to don’t think inflation will come back to 2 per cent sustainably,” said Jon Day, a portfolio manager at Newton Investment Management. “We think central banks are being too dovish.”

Since December the Fed has been signalling that it expects to cut its key interest rate by the equivalent of three quarter-point cuts this year, from the current range of 5.25 to 5.5 per cent.

But stronger than expected jobs figures on Friday prompted officials including Dallas Fed president Lorie Logan and Fed governor Michelle Bowman to warn that it was too soon for the central bank to start cutting, and that an additional increase could be necessary if price pressures persist.

US Treasuries continued to sell off on Monday, pushing the interest rate sensitive two-year Treasury yield up 0.05 percentage points to 4.78 per cent, its highest level since November. Benchmark 10-year Treasury yields rose 0.06 percentage points to 4.44 per cent.

The shift in expectations could make it harder for other central banks to deliver multiple rate cuts this year without weakening their currencies against the dollar. Investors also say the surge in yields could derail US stocks, which have powered higher partly on hopes of rate cuts this year, with the S&P 500 index of blue-chip companies up more than 9 per cent since the start of the year.

“If the recent trend of higher energy and commodity prices continues, then it has the potential to cause a rerun of the 2022 financial market environment, which was a grim time for bonds and risk assets alike,” said Mike Riddell, a bond fund portfolio manager at Allianz Global Investors.

Investors could get more visibility on the outlook for interest rates on Wednesday when the US publishes inflation data for March. Economists polled by Reuters expect the headline annual rate to rise to 3.4 per cent. Readings for January and February have already come in above analysts’ forecasts.

A closely watched gauge of long-term US inflation expectations — the so-called five-year, five-year forward break-even rate — has nudged up to 2.26 per cent, from 2.15 per cent at the start of the year, boosted by a recent surge in oil prices. Brent crude, the international benchmark, is trading around $90 per barrel, up from $87 at the start of the month.

Some Fed officials have suggested that the latest rise in inflation may not last. Chair Jay Powell said last week that “it is too soon to say whether the recent readings represent more than just a bump”.

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