Investors are betting that the Federal Reserve will cut interest rates again at its policy meeting next month, which has dispelled the doubts about the prospects of rate cuts that still existed last week and laid the foundation for the rise in US bonds.
Over the past three trading days, the new open interest of futures contract traders linked to the Federal Reserve’s benchmark interest rate has soared. The daily trading volume of the January contract last week even hit a record high for two consecutive days. Market pricing currently indicates that the probability of the Federal Reserve cutting interest rates by 25 basis points at its December meeting is approximately 80%, compared to only 30% a few days ago.
The shift in interest rate sentiment began last week with the delayed release of September’s employment data, which presented a mixed picture. Subsequently, New York Fed President John Williams hinted on Friday that given the weak labor market, he believes there is room for interest rate cuts “in the short term”, which further exacerbated the shift in interest rate sentiment.
“There are serious divisions within the Federal Reserve,” said Tracy Chen, portfolio manager at Brandyvan Global Investment Management. “The number of doves seems to exceed that of hawks.”
This week, Mary Daly, president of the Federal Reserve Bank of San Francisco, supported lowering interest rates at the next meeting, while Federal Reserve Governor Stephen Milan reaffirmed his reasons for a significant rate cut on Tuesday, despite the inflation rate remaining stubbornly above the central bank’s expectations.
Societe Generale strategist Subdra Rajapa said that although some other officials are more concerned about inflation and oppose interest rate cuts, Federal Reserve Chair Jerome Powell and his Allies on the policy-making committee “all agree to cut rates”. Given the recent weak economic data, including the labor market, “Powell will be able to convince the other members of the committee.”
The dovish sentiment in the futures market was echoed in the spot Treasury bond market. Jpmorgan Chase’s client survey this week showed that net long positions rose to the highest level in nearly 15 years.
On Tuesday, the yield on the 10-year US Treasury note fell below 4% for the first time in a month. This came after Kevin Hassett, director of the White House National Economic Council, became a hot candidate for the next chair of the Federal Reserve, boosting market expectations of lower interest rates over the coming year.
“The market generally believes that Williams’ remarks are Powell testing the waters,” said Blake Gwen, head of US interest rate strategy at RBC Capital Markets. “This week’s data also confirms this.”
Although most Wall Street strategists are currently calling on the Federal Reserve to cut interest rates in December, not everyone is as convinced as traders that a rate cut will definitely occur. Morgan Stanley strategists last week abandoned their previous prediction that the Federal Reserve would ease monetary policy, while jpmorgan Chase also tended to believe that the Fed would keep interest rates unchanged next month, “although the trend in December will still be very difficult to predict.
Tiffany Wilding, an economist at Pacific Investment Management Company, told Bloomberg Television: “We still think they will cut interest rates in December, but the outlook after that is somewhat uncertain.” From a growth perspective, the overall economy has performed very well this year. However, there are still downside risks in the labor market, and the inflation rate seems to be around 3%, significantly higher than the target level.
