Markets trim rate cut bets before Fed meeting

Sentiment wasn’t helped after China’s leaders disappointed investors hoping for large stimulus measures. Officials at the annual economic work conference said they would step up policy adjustments to support the economy in 2024, but didn’t provide details.

Investors are looking for further clues on next year’s reform agenda to bolster a sputtering post-pandemic economic recovery amid a housing crisis and piles of local government debt.

The market disappointment weighed on the risk-sensitive Australian dollar, which reversed all of Tuesday’s gains to stand at US65.60¢. Earlier in the session it had topped US66.12¢.

No urgency

In the near term, investors await the outcome of the Fed’s board meeting on Wednesday (Thursday AEDT) that will help set the market’s tempo for the rest of the year. Fed officials will also update economic and interest rate projections for the world’s largest economy.

While markets and economists wager that the Fed funds rate will remain on hold for the fifth month at the mid-point of 5.37 per cent, the latest economic figures have cast doubt on aggressive rate cuts.

Traders have slightly trimmed their bets on lower rates in 2024, with the first easing still fully priced for May. They imply a total of 110 basis points of cuts next year, from about 120 basis points.

The inflation surprise also stoked speculation that Fed chairman Jerome Powell will throw cold water on the Fed-easing buoyancy.

Commonwealth Bank, however, is still tipping a US rate cut as early as March because inflation will slow at a faster pace than expected, citing weakening household incomes that will eventually tip the economy into a recession.

“We expect the US consumer to pull back on spending so much so that the US economy falls into a mild recession and inflation settles below the Fed 2 per cent target,” said CBA economist Carol Kong.

Some investors, however, believe the fight against inflation is far from over, and more needs to be done.

Arif Husain, chief investment officer at T. Rowe Price, said the failure of most developed market central banks to get ahead of inflation made them more likely to keep policy rates at relatively high levels through much of next year.

In Australia, where the Reserve Bank started to raise rates later and less aggressively than its peers, bond futures indicate the cash rate will remain on hold at 4.35 per cent for most of 2024. They imply only an 8 per cent chance of a rate rise at the first policy meeting in February, and are fully priced for the first easing by December.

The federal government’s mid-year economic and fiscal outlook also showed it was on track to deliver an improved bottom line this financial year thanks to a tax revenue surge and postponed infrastructure spending.

The budget deficit is now projected at only $1.1 billion, down from $13.9 billion forecasted in May.