Warm inflation in the US is raising market expectations for a federal funds rate of 5% or higher for several months


With inflation showing no sign of abating, expectations are rising in financial markets for a 5% Fed-funds rate by March, which could bring more volatility across stocks, bonds and currencies.

Barclays expects the US interest rate target to reach 5% to 5.25% by February from the current level of 3% to 3.25% amid “more aggressive, front-loaded” interest rate hikes by the Federal Reserve. sees note released on Thursday. Meanwhile, Fed funds futures traders see a 38.8% chance that rates will reach at least that level by next March, according to the CME FedWatch Tool.

To see: Some economists say the Fed’s key interest rate could exceed 5% after September inflation data

The game changer was a warmer-than-expected consumer price index report for September, which featured worrisome jumps in core readings that exclude food and energy and produced the seventh straight 8%-plus annual headline reading. Until now, many in financial markets have struggled to adjust to the prospect of a fed funds rate of around 4% by November, which would be the highest level in more than a decade. Now that traders and economists are pointing to the prospect of a Fed funds rate hike of around 5% – a level last seen in 2006 – investors are preparing to dump stocks and bonds and favor the dollar.

Tom di Galoma, managing director of interest trading at Seaport Global Holdings in Greenwich, said a 5% fed funds rate “will be negative for equities and yields and will lead to more bond selling.” It would also be absolutely devastating to the economy. At that time, the credit market will be completely closed, and banks will not approve housing loans or loans to companies.”

“People are completely surprised by rates that have changed the way they have in the last three months. I certainly didn’t expect a 5% 2-year rate, but it looks like that’s where we’re going,” di Galoma said by phone. “We’re not going to see a shallow recession, we’re going to see something more massive than what people are used to. because everywhere in the world is slowing down’ and all these markets are in the process of ‘crashing’.

Rex Nutting: Everyone is looking at CPI through the wrong lens. The best measure shows that inflation has fallen short of the Fed’s target over the past three months.

On Thursday, investors reacted to the September CPI report, first with all three major U.S. stock indexes, the DJIA,
+2.83%

SPX,
+2.60%
before bouncing back sharply to finish higher. Analysts said stocks should squeeze higher after a six-day selloff that left the S&P 500 at its lowest close since November 2020 on Wednesday.

The policy-sensitive 2-year Treasury rate TMUBMUSD02Y,
4.464%
The 30-year yield TMUBMUSD30Y rose to almost 4.5%, a 15-year high.
3.910%
3.93%, or the highest since January 3, 2014.

Ahead of Thursday’s CPI report, Treasury Secretary Janet Yellen reportedly raised concerns about the potential for problems in the US government debt market due to weak trading conditions. “We are concerned about the loss of adequate liquidity in the market,” he said after his speech on Wednesday.

The potential lack of liquidity in the $23.7 trillion market for Treasurys is just one of many fissures in financial markets as central banks raise interest rates at the fastest rate in decades – fueling debate over whether the next financial crisis is imminent.

Talk of a 5% Fed-funds rate has circulated for at least the past month, but it always seemed to be hidden behind the more general dialogue about what the Fed might do in November.

The reason the CPI report moved the needle is because “hopes that lower inflation will come from addressing supply chain adjustments have faded and improvements in the supply chain that have been passed on to consumers are still not enough,” he said. Will Compernolle, New York-based chief economist at FHN Financial. “The era of globalization, which puts downward pressure on commodity prices, may end.”

According to him, the MES chief economist expects a 6% Fed-funds rate at some point, which will further strengthen global recessionary winds and keep the dollar strong. Compernolle said by phone on Thursday that the first thing that could disrupt the global economy is “Europe in a severe recession.”

For Ben Emons, managing director of global macro strategy at Medley Global Advisors in New York, “There is no doubt that US inflation is spiraling out of control.”

Equity markets have not yet priced in the prospect of a 5% fed funds rate until the first half of 2023, Emons wrote in an email on Thursday. A direct result of the latest inflation update, which confirmed inflation at an annual average of 8%, is that it “puts the Fed on track to follow what Brazil’s central bank is doing,” which is to raise rates above inflation.



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