Bond traders bet on aggressive rate cuts in 2024
Bond traders are ignoring the Federal Reserve officials playing down rate cuts in 2024 and are instead betting that Friday’s US inflation report will open the door for early and aggressive monetary easing.
Several Fed officials suggested over the weekend that talk of rate cuts in the world’s largest economy was “premature” despite the central bank flagging last week that there was ample room to lower borrowing costs. This kicked off a sharp rally in the bond market.
Tapas Strickland. Flavio Brancaleone
The US core personal consumption expenditures price index for November, an inflation gauge monitored by the Fed, is expected to rise 0.2 per cent, although National Australia Bank warns that given the softness in the producer price index, the data could surprise.
“Should it print at 0.1 per cent, core inflation on a six-month annualised basis would fall to 2.1 per cent,” said Tapas Strickland, head of market economics at National Australia Bank. Such an outcome would be a smidgen away from the Fed’s 2 per cent goal.
Over the weekend, the White House’s Lael Brainard, a former US Fed vice chairwoman, said, with regard to inflation, that hindsight told “an incredibly strong story that the supply side was fundamentally broken” as Fed officials tried to play down the prospect of imminent rate cuts.
New York Federal Reserve president John Williams told CNBC it was too soon to discuss unwinding the tightening cycle and Chicago Fed president Austan Goolsbee said to CBS that monetary policy was still dependent on economic data.
Atlanta Fed president Raphael Bostic, meanwhile, painted a cautious outlook to Reuters and said he expected two rate cuts in 2024, but not before the third quarter of the year.
The timing, however, is at odds with the market’s aggressive pricing after the Fed’s rate projections released last week forecast three-quarters of a percentage point of cuts in 2024, which would take the policy rate to between 4.5 per cent and 4.75 per cent by December next year.
After Mr Williams’ comments, bond traders briefly dialled back their rate cut expectations, before retracing their steps. They imply an 80 per cent chance the Fed will ease in March, from 89 per cent on Thursday, but remain fully priced for a move by May and ascribe at least five rate cuts next year.
NAB expects the Fed to lower its benchmark four times next year with the first move expected in June, and a total of 275 percentage points worth of cuts by 2025.
This is more than ANZ’s 200 percentage-point prediction. “We expect conditions for rate cuts will emerge from mid-2024 and that a patient Fed will start cutting in Q3,” said Tom Kenny, a senior economist at ANZ.
While US two-year bond yields rose 6 basis points to 4.44 per cent, as the market trimmed expectations for a rate cut at the Fed’s January meeting, the return on the US 10-year bond retreated three basis points to 3.93 per cent.
Recovering $A
The Australian dollar, meanwhile, stood tall at US67.06¢, within reach of an almost five-month top of US67.28¢ that was touched twice last week. It has surged US4¢ since late October on expectations the Fed will reduce borrowing costs well ahead of the Reserve Bank of Australia.
In Australia, bond futures imply the central bank will leave the cash rate at 4.35 per cent at its first 2024 policy meeting in February and are fully priced for a rate cut in August. They imply a 95 per cent chance of a second rate cut by December next year.
While financial markets tend to be more accurate than economists, both groups underestimated the number of RBA rate increases in 2023. Last year, traders had wagered the cash rate would end 2023 at 3.8 per cent, versus 4.35 per cent currently.
Economists were even further off the mark, forecasting the policy rate at just 3.6 per cent. Almost one-third of the 34 surveyed by The Australian Financial Review late last year predicted the central bank would have started easing by now.
“Predicting the behaviour of central bankers is extremely difficult in normal times [and] we are far from normal times,” said Angus Coote, co-founder of Jamieson Coote Bonds.
“That said, the 10-year bond market rate got close to meeting the cash rate. I think the resilience of labour markets caught economists offside and as a result [we have seen] the stickiness of services inflation,” he added.
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