The recent frenzy in global stock, bond, and gold markets indicates that traders generally believe that the Federal Reserve's current interest rate hike cycle has come to an end. The current focus of debate is when the central bank will start cutting interest rates and how much it will be.
On Monday morning trading in Asia, spot gold surged all the way to $2146.79 per ounce, approaching the $2150 per ounce mark and setting a new historical high. Forexlive analyst Eamon Sheridan said that this is because the market's expectation of future Fed rate cuts is stimulating investors to buy gold in large quantities.
In fact, the sharp surge in gold prices during the morning is just a microcosm of the recent collective surge in the stock and bond commodity markets. The hope for the Federal Reserve to end interest rate hikes has driven a comprehensive rise across asset classes so far in November.
The Dow Jones Industrial Average rose sharply by 2.4% last week, marking its fifth consecutive week of gains and the longest consecutive week of gains since the end of 2021. The S&P 500 index also rose 0.8% in a single week, closing at its highest level since March 2022.
The pent up buying in the US treasury bond bond market pushed the 10-year US bond yield down to 4.225%, the lowest level since early September. The yield of two-year US treasury bond bonds, which is particularly sensitive to interest rate expectations, recorded the largest weekly decline since March last week, which coincided with the collapse of Silicon Valley banks.
From the perspective of pricing in the interest rate market, the degree of dovish shift in market bets is undoubtedly astonishing. As shown in the figure below, the expectation of the Federal Reserve's interest rate cuts over the next three years over the past month has led to a significant downward shift in the entire interest rate pricing curve.
Whether the US economy will achieve a soft landing or a spiral decline, neither of these situations seems to prevent people from believing that interest rate cuts are imminent. At present, industry insiders have comprehensively priced the Federal Reserve's interest rate cut in May next year, and the probability of betting on a rate cut in March next year has exceeded 50%.
Looking at the entire year, the current market expectation is that the Federal Reserve will cut interest rates by at least 125 basis points next year (equivalent to five 25 basis point rate cuts), which seems to have paved the way for further decline in US bond yields and a sustained rebound in the stock and bond commodity markets.
It is worth mentioning that the current expectation of interest rate cuts by major central banks around the world next year is not only limited to the Federal Reserve. According to industry insiders' statistics on interest rate swap contracts, traders have fully priced the following time points when central banks of various countries first lowered interest rates:
Next April: European Central Bank, Bank of Canada
May next year: Federal Reserve
Next June: Swiss Bank, Bank of England
Next August: New Zealand Federal Reserve
Next December: Reserve Bank of Australia
Market bets are increasingly losing control of the central bank
An interesting detail is that although Federal Reserve Chairman Powell's final statement before last Friday's silence was still cautious, stating that it was still too early to speculate on when policy would relax, market participants who were betting on the Fed's turn did not seem interested and were still willing to bet that interest rate cuts would come early.
Powell stated last Friday that his policy setting "has penetrated into restrictive regions, which means tight monetary policy" is slowing economic activity, which is his strongest signal so far that officials may have ended interest rate hikes.
But Powell's comments are also full of caution. "It is too early to confidently conclude that we have taken sufficient restrictive positions," he said in a speech at the Spearman College in Atlanta
Powell said that the recent slowdown in inflation and wage growth both prove that the Federal Reserve's interest rate hikes are being successful, and officials expect the economy to further cool down. Therefore, although he said that officials "will further tighten policies in appropriate circumstances," he also stated that the threshold for further interest rate hikes has been raised. Powell's speech is expected to hold officials still at the December meeting, while retaining public guidance that the next interest rate change is more likely to be a rate hike rather than a rate cut.
The Federal Reserve has raised the benchmark federal funds rate at the fastest pace in 40 years in the past year and a half, with the most recent rate hike being in July of this year, raising the rate to 5.25% -5.5%. If the third consecutive policy meeting this month is held without action, it will keep the interest rate range unchanged until at least the end of January next year.
Regarding why Powell's speech last Friday failed to change market dovish bets, Boock Report author Peter Boockvar said, "Powell attempted to counterattack, but the effect only lasted for a few seconds in the US Treasury market. The market believed that the Federal Reserve had already completed a rate hike and would cut rates next year, while Powell's speech that day was intentional (biased towards an eagle). I believe Powell wanted the market to remain cautious."
LPL Financial's Quincy Krosby pointed out that the market firmly believes that the Federal Reserve made a dovish decision in November and will begin a rate cutting cycle before mid-2024 (or even earlier), which refutes the slogan of "higher and longer" interest rates. She said, "Although both the dovish and hawkish sides of FOMC seem to revolve around a more 'cautious' policy approach and acknowledge that the policy is still appropriate, the market clearly does not agree."
Of course, as Deutsche Bank has previously calculated, this is already the seventh time in this tightening cycle that industry insiders are betting that the Federal Reserve will make an early dovish turn, and the previous six attempts have all ended in failure. This has also raised concerns among some market participants about whether the recent joint rebound in the stock and bond markets will be excessive?
Mark Dowding, Chief Investment Officer of RBC BlueBay Asset Management in London, stated that he expects returns to rise in the coming weeks after investors' thirst for returns in November. At the beginning of November, we held a constructive attitude towards bond maturities, but as yields declined, we had already taken profits and turned into short positions on the upside. We believe that the market's forward-looking judgment of the Federal Reserve is still too early.
Looking ahead to this week, the release of a series of economic data will undoubtedly test the courage of bulls in the stock and bond markets, especially Friday's non-agricultural data, which is expected to bring a new peak to the market trend. Economists surveyed by the media predict that as striking workers return to work, the number of new non-agricultural jobs in November is expected to increase from 150000 last month to 200000. The unemployment rate is expected to stabilize at 3.9%, while wage growth is expected to slow slightly to 4%.