Investors and the Fed are at Odds Over the Interest Rates

Investors and the Fed are at Odds Over the Interest Rates

Investors' and Federal Reserve officials’ views on the US interest rates this year run contrary to each other, broadening the gap between the policymakers and market expectations. Markets suggest the central bank will loosen up and shift its months-long campaign to raise interest rates. Senior Fed officials maintain they will not deviate from the course.

The difference stems from the outlooks on future inflation, which has subsided in recent months but still remains high by historical standards. Fed projections from December showed officials expect to raise rates to just above 5% this year and maintain that level until at least the end of the year in order to cool the economy enough to get inflation under control. Futures markets indicate the Fed will stop short, capping its policy rate between 4.75 percent and 5 percent, before implementing half of a percentage point’s worth of interest rate cuts from peak levels by December.

“There is a very clear disconnect and it is a disconnect about inflation,” said Priya Misra, head of rates strategy at TD Securities.

Bets on lower rates have increased as investors have lowered their inflation expectations. On January 20, the one-year US inflation swap, a derivatives contract that reflects inflation expectations for a year from now, was 1.77 percent, its lowest level in more than two years, according to Refinitiv. Another market measure, the so-called one-year break-even inflation rate, currently stands at 2 percent.

“The market is pricing cuts as there is the high conviction the data will turn weak,” said Kavi Gupta, co-head of rates trading at Bank of America.

The jobs and wages data are “the last piece you needed to see to be convinced that the decline in inflation is sustainable”, said Eric Winograd, an economist at AllianceBernstein.

Nevertheless, St Louis Fed President James Bullard reiterated to the Wall Street Journal last week Fed officials should boost the Fed funds rate above 5% as "quickly as we can" before pausing rate hikes to bring down inflation.

In a speech Thursday at the University of Chicago School of Business, Federal Reserve Vice Chair Lael Brainard said while there are encouraging signs inflation has come down, the central bank should stay the course of restrictive monetary policy.

To read more follow the article in Financial Times:

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