Traders are raising their bets that US interest rates will stay higher for longer after the central banks of Australia and Canada unexpectedly hiked borrowing costs to fight inflation and the US labor market turned out to be stronger than expected.
Treasury futures market prices now clearly point to a quarter-point rate hike by the US Federal Reserve in July after a lull in June, while expectations of rate cuts for later this year have fallen, according to data from Refinitiv.
Strong economic data out of the US in recent weeks, including a robust jobs report, has fueled these bets, which traders added after the decisions in Canada and Australia.
Citing recent data pointing to rising “upside risks” to higher inflation, the Reserve Bank of Australia defied consensus forecasts on Tuesday by raising its target for spot interest rates by 0.25 percentage point to 4.1 percent, the highest level since 2012 .
The Bank of Canada followed suit on Wednesday, raising rates from 4.5 percent to 4.75 percent for the first time since January on strong first-quarter gross domestic product data — surprising investors who thought rates would remain unchanged .
Consumer prices in Canada rose for the first time in 10 months in April and “concerns have mounted” that inflation could remain “materially” above 2 percent, the bank said.
The BoC’s decision to retighten its tightening pushed local 10-year Treasury yields to their highest levels since April and led to a sell-off in US Treasuries of various maturities. It also served as a “warning signal” for central banks, such as the Fed, that were considering a pause, says Elwin de Groot, head of macro strategy at Rabobank. Yields rise when prices fall.
Concerned that further tightening in June could exacerbate a potential credit crunch triggered by the collapse of several regional banks in March, some rate setters on the Federal Open Market Committee have suggested in recent weeks that the central bank could raise rates in July after pausing her aggressive tightening cycle when it meets next week.
Fed Governor Christopher Waller, a voting member of the committee, said late last month that he was not in favor of halting rate hikes, even as “prudent risk management” suggested pausing in June and raising rates again in July.
Markets still expect a 25 basis point increase in July to be the last of the current cycle. But some investors who previously thought the Fed would cut rates significantly later this year recently backed out of those bets, taking about 0.8 percentage point of expected year-end cuts out of market prices since early May. .
Wednesday’s decision by the BoC briefly raised the probability of a rate hike by the Fed in July from 80 percent to 90 percent, ING analysts said.
“Investors are starting to see a pattern emerging,” with this week’s moves going against “the prevailing narrative that central banks are about to pause their rate hikes,” said Jim Reid, an analyst at Deutsche Bank.
The Fed faces many of the same problems that central bankers in Canada and Australia grapple with. The US labor market remains tight, and while headline inflation has been on a downward trajectory since June 2022, core inflation, which takes away volatile food and energy prices, has barely eased since late last year.
The BoC had forced the market to “rethink what the Fed might do, not necessarily next week, but down the road,” said Mike Zigmont, head of trading and research at Harvest Volatility Management. “Maybe a Fed easing later in the year isn’t as likely as everyone thinks.”