Traders of short-term cash markets have begun to bet that the Federal Reserve will embark on a hiking cycle, kicking off at the start of 2023.
Specifically, over the past six weeks, markets have priced in two additional rate hikes that weren’t there before.
They now expect the Federal Reserve’s current 0% to 0.25% benchmark interest rate range will increase by more than one percentage point by the end of 2024, up from an earlier forecast of a half of a percentage point climb for the same stretch.
Market-implied expectations for U.S. benchmark rates are reflected in the difference between eurodollar futures contracts, set to mature in March, and contracts set to mature in December 2024.
The eurodollars market is where companies and banks outside of the U.S. can lock in an interest rate to borrow funds in the future. It also serves as an arena where traders can speculate on where interest rates are headed.
The build-up in rate hike expectations comes as the prospects for the U.S. economy brighten. The possibility of another $1.9 trillion fiscal relief package, along with the accelerating vaccine rollout, has bolstered hopes the U.S. eventually will return to more normal levels of economic activity and make headway toward achieving full employment.
At the same time, investors fret any hawkish turn from the U.S. central bank could spark panic across financial markets and undo the gains tied to a tentative economic recovery since early last year.
To be sure, much of the rate-hike expectations are back-ended, with the first rate hike forecast to arrive in 2023.
But that still would mean rates start to rise a year earlier than senior Fed officials have been forecasting, via the central bank’s so-called “dot plot” projection, which indicates benchmark fed funds rates would remain in today’s rock-bottom range through the end of 2023.
Fed Chairman Jerome Powell has pushed back on suggestions that the central bank might be forced to prematurely tighten monetary policy. In recent speeches, he underlined his commitment to keeping policy accommodative as long as needed to support the recapture of jobs lost during the pandemic.
Yet, with rate hike expectations mostly built up in the distant future, at the same time the picture for growth, inflation and unemployment lacks clarity, investors said it remains unclear if the central bank can, or should, dissuade markets from betting on a liftoff, slightly ahead of schedule.
“It’s a little tricky for them to push back against rate hike expectations that are so far in the future,” said Tom Graff, head of fixed income at Brown Advisory, in an interview.
In markets, the 10-year Treasury note yield TMUBMUSD10Y, 1.273% ended at 1.297%, around its highest level since last February. Stocks struggled for direction as the Dow Jones Industrial Average DJIA, +0.29% eked out a record close, while the tech-heavy Nasdaq Composite COMP, -0.58% sank.