Investors are also speculating that Fed Chairman Jerome Powell may accelerate hikes with an unusual 50 basis point move in March after he struck a hawkish tone at this week’s meeting. The bets reverberated through the markets, leading to declines in short-term bonds and a rally in the dollar. CME open interest data following Wednesday’s settlement showed a buildup of new short positions across the Treasury curve as yields rose.
The pace of rate hikes indicated by the markets, which at one point Thursday showed a 100% probability of five quarter-point hikes by 2022, slowed slightly in early New York trading, although traders are not far off that level. They also discount about 30 basis points at the March meeting, suggesting there are some bets on a hefty half-point hike.
U.S. gross domestic product growth during the final quarter of 2021 was stronger than expected at an annualized rate of 6.9%, although there was little reaction in rate pricing given that the market has already taken an aggressive tilt following the Fed meeting.
Shortly after Wednesday’s Fed policy announcement, Nomura Holdings Inc. modified its forecast for a Fed rate hike, with the bank now forecasting a 50 basis point hike in March. Money markets are currently discounting a half-point increase for the May policy meeting. On Thursday, the three-month dollar Libor rate was up more than two basis points, the largest increase since November 2020.
“People are taking a 50 basis point increase seriously,” said Rishi Mishra, an analyst at Futures First.
The tone of Powell’s press conference left no doubt that price stability takes priority over other policy goals, meaning there’s even an upside risk of six hikes, Bloomberg Intelligence’s Anna Wong said in a note.
“However, my biggest disagreement with market pricing is, however, in the context of a terminal rate in the cycle, where the market discounts rates to be above 2%,” said Mark Dowding, chief investment officer at BlueBay Asset Management. “I think this is 100 basis points too low and I foresee rates reaching 3% by 2024″.
Bets on faster policy tightening in recent months have led to increased volatility in markets. U.K. bonds took the biggest hit on Thursday, when two-year yields rose to the highest level since 2011. The Treasury curve flattened, as two-year yields rose three basis points, while their 10-year peers fell the same percentage.
Rate hike fever spread across Europe, with traders betting on a 25 basis point move, to 0.5%, by the Bank of England next week. Money markets expect the Bank Rate to stand at 1% in June and rise to nearly 1.5% in December. That has not been enough to prop up the pound against a recovering dollar.
The European Central Bank, which has always been more dovish than its major peers, is expected to raise its deposit rate by 10 basis points to minus 0.4% in September, desirable October. Monetary policymakers led by Christine Lagarde will meet on February 3.