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Wall Street Retreat! Fed's expectations of interest rate cuts during the year "zeroed"

author:Golden Ten New Media
Wall Street Retreat! Fed's expectations of interest rate cuts during the year "zeroed"

The resilience of the US economy has been surprising investors, inflation stubbornness has been proven to be underestimated, and the Fed has won the divergence with the market.

The continued strength of the economy has led to the realization that bets on a sharp rate cut by the Fed this year may be wrong, which could undermine key support for stock market gains in 2023.

According to Tradeweb, the derivatives market shows that investors now expect the Fed's target rate to remain at 5 percent by the end of the year, up from just over 4 percent last month. The current target range for the federal funds rate is 5%-5.25%.

Wall Street Retreat! Fed's expectations of interest rate cuts during the year "zeroed"

Previous expectations that interest rates would fall by December helped boost stock markets, especially those of big tech companies such as Apple, Amazon and Meta.

Some said that while the U.S. economy and corporate profits remain strong, higher interest rates in the second half of the year could weigh on stocks. Many also noted that shares of most listed companies have weakened this year, despite gains in major stock indexes.

Rhys Williams, portfolio manager at Spouting Rock Asset Management, said:

"The sharp rise in the Nasdaq was led by only a handful of stocks, but most of the other stocks were falling. This really reflects how nervous people are about the prospect of no rate cuts. ”

Investors have repeatedly underestimated the resilience of U.S. economic growth under the pressure of rising interest rates, and Friday's non-farm payrolls report is just the latest setback they have encountered. Inflation has also proven to be much more stubborn than investors predicted 12 months ago. Last summer, expectations for inflation for the year ahead suggested that inflation would quickly fall back to the 2% range starting in mid-2023. However, the latest consumer price index recorded 4.9%.

Wall Street Retreat! Fed's expectations of interest rate cuts during the year "zeroed"

Rich Steinberg, chief market strategist at Colony Group, said a tight labor market means the Fed may skip a rate hike this month but will consider raising rates again at its next meeting this summer. He said:

"The wording for policymakers will be, 'Let's wait and see what happens, the July rate decision will again rely on data.'"

The disappearance of interest rate cut bets has pushed up short-term Treasury yields, which are closely tied to investors' expectations for Fed policy. The two-year Treasury yield closed at 4.501% on Friday, up from 4.064% at the end of April, but the climb did not alarm other markets, with the S&P 500 closing up more than 1%. In contrast, rising U.S. Treasury yields hit stocks hard last year, sending the S&P 500 down nearly 20 percent.

Investors said that under the current model, stocks are benefiting from Fed rate cut expectations and signs that the economy will remain strong, making it particularly challenging to predict where the market will go in the future.

Ellen Zentner, chief U.S. economist at Morgan Stanley, insisted on her view that the Fed will leave rates unchanged at its June meeting and unchanged for the rest of the year, followed by a rate cut expected to begin in the first quarter of 2024.

Some investors have shown confidence that the U.S. economy is avoiding recession. Fixed income traders continue to buy junk bonds and demand yields that are only 4 to 5 percentage points higher than U.S. Treasuries, suggesting that many believe defaults by low-rated companies will remain rare. During past recessions, investors typically demanded that junk pre-yields be more than 8 percentage points higher than U.S. Treasury yields to compensate for increased risk.

Wells Fargo analyst John Gregory said that while the possibility of a recession remains, those bets could be profitable if the economy avoids it, attracting many investors to continue bidding for risky assets. Gregory said:

"There is enough positive economic data at the moment that there is still faith that a soft landing is possible for the economy. If that's the case, investors will feel they need to increase their exposure. But the downside risk is that the recession will be worse than expected. ”