Traders bet on five Fed rate hikes this year

Traders are raising their bets on a further rise in borrowing costs as money markets see nearly five interest rate hikes from the Federal Reserve this year and another four by the Bank of England.

Investors are also speculating that the Fed chairman, Jerome Powell, accelerated gains with a rare 50 basis point move in March, after taking a dovish tone at this week’s meeting. The bets weighed on the markets, causing short-term bonds to decline and the dollar to rally. CME open interest data following Wednesday’s sell-off showed a build-up of new short positions across the Treasury curve as yields rose.

The pace of rate increases indicated by markets, which at one point on Thursday showed a 100% chance of five quarter-point hikes by 2022, eased slightly in early New York trading, though traders are not far from that level. They also discount around 30 basis points at the March meeting, suggesting there are some bets on a hefty half-point increase.

US gross domestic product growth for the final quarter of 2021 was stronger than expected at 6.9% annualized, though there was little price reaction in rates as the market has already taken an aggressive slant after the Fed meeting.

Shortly after the Fed’s policy announcement on Wednesday, Nomura Holdings Inc. revised its forecast for the Fed’s rate hike, with the bank now forecasting a 50 basis point rate hike in March. Money markets are currently pricing in a half point increase for the May policy meeting. On Thursday, the three-month Libor rate for the dollar rose more than two basis points, the biggest increase since November 2020.

“People are taking a 50 basis point hike seriously,” said Rishi Mishra, an analyst at Futures First.

The tone of Powell’s press conference leaves no doubt that price stability takes precedence over other policy objectives, meaning there is even an upside risk of six hikes, said Anna Wong of Bloomberg Intelligence in a note.

‘Too low’

“My biggest disagreement with market pricing though, though, is in the context of a terminal rate in the cycle, where the market is pricing in rates above 2%,” said Mark Dowding, chief investment officer at BlueBay. Asset Management. “I think this is 100 basis points too low and I expect rates to hit 3% in 2024.”

Bets on faster policy tightening in recent months have led to more volatility in markets. UK bonds took the biggest hit on Thursday, as two-year yields rose to the highest level since 2011. The Treasury curve flattened, as two-year yields rose three basis points, while peers at 10 years fell the same percentage.

Rate hike fever swept 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 almost 1.5% in December. That hasn’t 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 from October. Those responsible for monetary policy led by Christine Lagarde will meet on February 3.