The central bank has not relented, but the market has turned first: the Federal Reserve will cut interest rates in June next year and cut 100 basis points for the whole year!

Finance Associated Press, November 6 (edited by Xiaoxiang) Bond investors and interest rate traders are increasingly betting that interest rate cuts by the world's major central banks will begin before the summer, challenging the narrative that policymakers will keep interest rates "higher and longer" for the foreseeable future.

Markets are now fully pricing in the Fed to cut rates for the first time in June next year and will implement a rate cut of nearly 100 basis points by the end of 2024. The ECB is also expected to cut interest rates of a similar magnitude, possibly as early as April next year. In the UK, the Bank of England is expected to cut its benchmark interest rate by almost 70 basis points next year.

These dovish U-turn bets could be a big problem for central bankers. They have acknowledged over the past few weeks that expectations of policy tightening have somewhat boosted bond yields and helped cool the economy.

(Changes in interest rate market bets on interest rate cuts in September next year)

Henry Cook, senior economist at MUFG, said, "Officials will want to resist this [bet on rate cuts] for as long as possible to avoid an easing of tightening financial conditions." ”

But he also noted that if economic data continues to deteriorate in the coming months – as Cook expects, the position of central bankers will become increasingly difficult to sustain.

Rates cut bets surged

There is no doubt that the sharp shift in interest rate expectations in the market over the past week has had a clear impact on the movement of various asset classes.

On Friday, traders rushed to bring forward the timing of the first U.S. rate cut from July to June after data showed U.S. nonfarm payrolls growth slowed more than expected and the unemployment rate rose.

At the same time, the 10-year Treasury yield quickly plummeted from 5% to 4.5% in less than two weeks as the market expected that the rate hikes were over.

These pricing underscore long-standing post-2021 market skepticism about the central bank's policy path, when a number of central banks, led by the Federal Reserve, falsely insisted that rising inflation would prove transitory.

And for rate-setters, whether officials support a cut right now, a drop in bond yields is likely to ease financial conditions and weaken the impact of the rate hikes they have already implemented.

Sebastian Vismara, senior economist at BNY Mellon Investment Management, said, "The challenge is how to prevent the market from getting too excited. As long as there isn't any credible risk of rate hikes, I think the market will continue to have this tendency to price in rate cuts. ”

How will central banks respond?

Of course, some industry insiders are now concerned that the current overly aggressive betting on the pivot could become a "fatal wound" for traders in the interest rate market in the future – this is not the first time they have been on the wrong side in interest rate trading. Time and time again, market traders have either tried to call a premature halt to rate hikes or priced in tightening bets that seem to be excessive in hindsight.

Vismara said such an outcome "could be self-defeating, and the central bank may have to turn hawkish again and try to reverse the situation."

Fed Chair Jerome Powell made it clear after last week's interest rate meeting that the Fed is not currently discussing or considering cutting interest rates. And ECB President Christine Lagarde has previously said that any discussion of when to cut rates is "completely premature".

Mark Dowding, chief investment officer at BlueBay Asset Management, is skeptical that no major central bank will cut interest rates for at least the next nine months. He said inflation was still above target and so far there was little indication that the U.S. economy would be severely weakened. ”

Société Générale strategist Adam Kurpiel and his colleagues also said that those who expect the ECB to cut interest rates by 100 basis points next year will be disappointed. "The latest FOMC meeting provides an excuse for markets to reconsider the rate-cutting cycle, as well as a reason for risk assets," they wrote. But it may turn out to be a lot more complicated than the market hoped. ”

However, David Zahn, head of Franklin Templeton's European fixed income division, believes that while it may be too early to bet that the ECB will cut interest rates from April, in order to boost the economy, the ECB will have to ease policy further on top of current pricing in the future. "It's clear that they're done raising rates, so now it's just a matter of when they're going to start cutting rates," he said. You'll want to start thinking about investing for the long term in your portfolio to prepare for a sustained cycle of interest rate cuts in Europe. ”

(Finance Associated Press Xiaoxiang)