- Money market managers have fully priced in the prospect of a 0.5% rate hike by the U.S. Federal Reserve at its next policy meeting.
- Median forecast for markets continues to price in a rates hitting between 2% and 2.5% by the end of this year, which is a neutral stance that could possibly engineer a soft landing for the U.S. economy.
With one of the U.S. Federal Reserve’s most hawkish policymakers rattling sabers and threatening a rate hike of as high as 0.75% at the central bank’s next meeting in May, investors are understandably concerned if the rebound in stocks has been premature.
At a virtual presentation to the Council on Foreign Relations on Monday, U.S. Federal Reserve Bank of St. Louis President James Bullard noted,
“More than 50 basis points is not my base case at this point, I wouldn’t rule it out, but it is not my base case here.”
Nevertheless, Bullard also said that the Fed shouldn’t rule out offhand rate increases of 0.75%, especially if it should need to move quickly on inflation.
U.S. stocks immediately buckled on that possibility but rebounded alongside economic data that proved better-than-expected, especially for housing starts.
At this point, a rate hike of more than 50 basis points in May seems unlikely, at least according to money market traders who have fully priced in such a move by the central bank.
Fed officials including Chairman Jerome Powell have already signaled their openness and preparedness to raise rates in half-point increments if necessary, and money market traders are taking note.
But the repricing in money markets threatens to exacerbate a selloff in bonds, sending yields soaring and putting renewed pressure on equities, regardless of economic data.
For now at least, money markets have not gone the way of Bullard’s forecast of rates hitting as high as 3.5% by the end of this year, with traders betting that borrowing costs are likely to hit 2.28% by the end of 2022, in line with the Fed’s so-called “dot plot” that has rates rising to between 2% to 2.5% – a median course for the U.S. economy as the Fed tries to engineer a soft landing.
