Since the Federal Reserve hinted at the possibility of a rate cut last autumn, Wall Street traders, economists, potential homebuyers, and car buyers have almost everyone started to ponder a question: when will the Federal Reserve start cutting rates? At the end of last year, due to the rapid decline in inflation in the United States, the market bet that the Federal Reserve would aggressively cut interest rates. It cut interest rates for the first time in March this year, with seven cuts made within the year.
But now, as the US economy shows astonishing vitality, the market is turning its attention to another question: can the Federal Reserve still fulfill the three rate cuts implied by the dot matrix this year? Even, will the Federal Reserve cut interest rates this year? Investors in US stocks and bonds have also begun to adjust their investment strategies.
The market is beginning to bet on the possibility of the Federal Reserve not cutting interest rates this year
After last week's unexpectedly strong non farm payroll data, the Chicago Mercantile Exchange (CME) Federal Reserve observation tool showed that the market's likelihood of the Fed's first interest rate cut in June decreased from 55.2% a week ago to 50.8%. If the latest Consumer Price Index (CPI) data to be released on April 10th exceeds expectations again, this expectation may fall below 50%. The market currently expects the core CPI to rise by 0.3% month on month in March, which is clearly too fast for the Federal Reserve.
Some market participants have already shouted that the Federal Reserve may not cut interest rates this year.
According to Torsten Slok, Chief Economist of wealth management company Apollo Global Management, the US stock market has risen by $10 trillion in the past five months, which is a huge wealth growth for household balance sheets. The credit spread for investment grade, high-yield bonds, and loans has tightened. The issuance of investment grade bonds and high-yield bonds has rebounded significantly in the first three months of this year. IPO and M&A activities are also returning. These factors will all support consumer spending, capital expenditure, and recruitment in the coming quarters.
"If the economic data has been too strong, why should we cut interest rates? I think the Federal Reserve will not cut interest rates this year, and maintaining long-term high interest rates is the correct answer." Slocker also added that the enthusiasm for AI concept stocks will also make it difficult for the Federal Reserve to cut interest rates. "We are absolutely in the AI foam, and its side effect is that the rise of technology stocks will ease the financial situation, which makes it more difficult for the Federal Reserve to make decisions."
Ed Yardeni, President and Chief Investment Strategist of seller research firm Yardeni Research, also wrote in his report:; Quota; Investors may have to consider the possibility of not lowering interest rates this year. The recent rise in oil prices indicates that inflation still faces upward risks. Other expected non rate cuts this year include Mohamed El Erian, Chief Economic Advisor of Allianz Group. Erian stated that due to the stickiness of inflation, the Federal Reserve should wait for a few years before cutting rates.
In addition, Slock warned that Bank of America had previously stated that if the Federal Reserve did not cut interest rates for the first time in June, the first rate cut may be postponed until next year, as the second half of the 2024 presidential election will make it more difficult to cut rates.
In fact, not only market participants, but also Federal Reserve officials have become more hawkish. Last week, several Federal Reserve officials emphasized that there is almost no need to cut interest rates in the short term. On the contrary, the Federal Reserve needs more information about the direction of economic development.
Dallas Fed Chairman Lorie Logan said, "It's too early to consider a rate cut now. I need to be more clear on which path the US economy is currently on." Atlanta Fed Chairman Raphael Bostic said he supports a rate cut only once this year and will wait until the last three months. Minneapolis Fed Chairman Neel Kashkari questioned last Thursday, "If we continue to see strong employment growth, consumer spending, and strong GDP growth, then I have a question: why do we cut interest rates?" US stocks fell on the same day. Federal Reserve Governor Bauman expressed a more radical view last Friday that if US inflation remains above the Fed's long-term target of 2%, it may be necessary to further raise interest rates this year rather than lower them& Amp; Quota; Although this is not my basic expectation, I still believe that in future meetings, if inflation stagnates or even reverses, we may need to further raise policy interest rates& Amp; Quota; She said.
US stock and bond investors adjust their investment strategies
With this expected shift, US stock investors have rapidly increased their risk hedging.
In the first quarter, although the geopolitical situation became increasingly tense and the outlook for interest rates was uncertain, the market still expected the Federal Reserve to cut interest rates multiple times, and US stocks continued to hit new highs. The overall hedging demand for US stocks in the market fell to the lowest level in many years. But last Thursday, the Cboe Volatility Index (VIX), which measures the implied volatility of the S&P 500 index over the next 30 days, closed at its highest level since November last year. Although it fell slightly on April 5th, it remained above the 200 day moving average. After a tumultuous week, US stock traders who have been overly complacent for a long time have come to realize the necessity of hedging risks.
Joe Mazzola, head of trading at Charles Schwab, said, "Investors are starting to realize that the reason they were able to get through the first three months of this year smoothly is because the market has been betting on the possibility of a Fed rate cut." Now, investors are starting to hedge against the risk of US stocks again, causing the premium of three month put options relative to call option contracts to rise to the highest level since mid January. Investors have also increased their positions in tail risk hedging for the stock market, which is often used to prevent major stock market crashes rather than just minor adjustments.
In addition, some investors have also started using spreads, which are lower in cost than directly establishing a put position, but have less protection in a stock market downturn than the former. According to data released by Susquehanna International Group, investors have recently begun to establish a significant bearish spread against the S&P 500 index, the NASDAQ 100 index primarily focused on technology stocks, and the Russell 2000 index tracking the trend of small cap stocks.
Stephen Solaka of Belmont Capital Group manages hedging strategies for wealth management companies and institutions. He revealed that an increasing number of clients have recently requested to establish portfolio hedging for benchmark stock indices and individual technology stocks. He said this demand is understandable, "In addition to the uncertainty of the Federal Reserve's policy, other factors that cause investor anxiety include the upcoming first quarter financial reporting season, geopolitical tensions, and the US presidential election."
Rohan Reddy, Research Director of Global X Management, told First Financial reporters, "As market consensus continues to strengthen, even the most fearless bullish will become anxious about some unwelcome surprises. Of course, the situation may indeed become bumpy, and there may be more hedging sentiment and demand emerging in the future."
US bond investors also reacted quickly to the expected shift. Last week, the yield of multi maturity US treasury bond bonds was pushed to the highest level in recent years, and the yield of benchmark 10-year US treasury bonds jumped to about 4.40%. Peter Tchir, head of macro strategy at Academy Securities, said, "The recent economic data will certainly not give the Federal Reserve the impetus to cut interest rates in the short term, and the yield of US treasury bond bonds will therefore continue to rise. Strong data and rising oil prices may mean that the yield of 10-year US bonds will further rise to 4.5%~4.6%." In the options market, traders also began to extensively bet that the yield of 10-year US bonds will rise to 4.5%. This yield is equivalent to the level before the US bond market began a significant rebound at the end of November last year.
Corporate bond investors have also begun to bet on the possibility of the Federal Reserve disappointing investors again, leading to a surge in bearish positions in the iShares iBoxx high-yield corporate bond ETF (HYG). The fund is very sensitive to the level of US interest rates, and if the Federal Reserve really slows down interest rate cuts, these bearish bets will yield returns. Alex Kosglyadov, Managing Director of Derivatives at Nomura Securities International, said, "The only factor that can drive corporate bond volatility at the macro level is interest rates. The risk of unclear prospects for the Federal Reserve's interest rate cut could lead to a decline in the US corporate bond market."
Guy LeBas, Chief Fixed Income Strategist at Janney Montgomery Scott, told First Financial reporters, "The strong data reinforces the possibility of a later rate cut, leading to more investors being moderately bearish on bonds. These data also reduce the risk of a US economic recession, leading bond investors to demand higher returns."
This week, the United States will sell three-year, 10-year and 30-year treasury bond. BMO Capital's survey of investors showed that the proportion of investors who said they would need higher yields to buy treasury bond rose to 57%, compared with the average level of 47% in the past six months.