NEW YORK- While bond investors expect the US Federal Reserve to keep rates unchanged at its policy announcement on Wednesday, the market reaction could hinge on what Fed officials indicate about stubborn inflation and if their signals get more hawkish about the timing and extent of any easing this year.
Stronger-than-expected economic growth and stickier inflation this year has led investors to push back expectations on the US central bank’s first rate cut to June, from May, and reduce bets on how many cuts are likely this year.
Traders are now pricing in three 25 basis points cuts, in line with Fed policymakers’ median expectations made in December. The Fed is due to give updated economic projections and refresh its “dot plot” graphing policymakers’ interest rate projections at the meeting.
“What will be really interesting to see is if the Fed is still comfortable in the dot plots to still be showing the possibility of three rate cuts for this year,” said Matt Eagan, head of the full direction team at Loomis, Sayles & Co. “Or will they start to say we’ve got to push back against this a little bit longer.”
Benchmark 10-year Treasury yields rose to a near one-month high of 4.328 percent on Monday and have jumped from 4.052 percent a week ago as traders adjust for the possibility of a more hawkish Fed.
The Fed pivoted to a more dovish outlook in December on growing confidence that inflation was on track to its 2 percent annual target.
Inflation has since picked up, though analysts note that recent hotter-than-expected consumer and producer price index reports likely reflected seasonal factors.
Powell said after the Fed’s January meeting that the central bank wants more confidence that inflation will continue to decline before cutting rates.
“The Fed doesn’t want to break anything,” said Padhraic Garvey, regional head of research, Americas at ING, adding that when inflation gets closer to 2 percent the Fed will likely “use that opportunity as one to get rates off the highs.”
In the meantime, the Fed may caution about the prospect of near-term rate cuts.
“The main focus is which way they lean,” said Stephen Gola, head of US Treasuries Sales & Trading at StoneX Group.
An unexpected uptick in unemployment last month could keep the Fed circumspect on growth, offsetting some of the inflation concerns.
