By December 2023, traders predict the rate will drop to 2.7%, below the lowest dot on the Fed’s so-called dot plot of projections by policy makers released at the June policy meeting.
That dot plot had the Fed hiking to around 3.4% by the end of this year and 3.8% by the end of 2023, before coming back down in 2024, the median projections showed.
As to whether the market or the Fed will prove more accurate, bond traders can point to a recent victory. They were ahead of Powell and his colleagues in recent months in anticipating the central bank would have to get a lot more aggressive than it expected to take on the highest inflation in decades. Futures started pricing in the Fed’s May half-point rate hike and June three-quarter-point increase before policy makers’ signals.
Futures don’t explain whether markets see an outright US recession, or whether they simply expect inflation to subside and the Fed to lower rates in response. But history suggests that when investors are as convinced about future rate cuts as they are now, recessions tend to follow.
Since the 1980s, when expectations of cuts of at least 40 basis points persisted, an economic downturn followed within the next 18 months, according to data compiled by Bloomberg.
Policy makers have said they will keep raising rates until they see clear evidence that inflation is coming down. Investors could be anticipating that the Fed’s sharp rate increases may cause demand and the economy to slow so much that the central bank will need to cut rates next year to stimulate growth, said Krishna Guha, a vice chairman at Evercore ISI.
“The odds are that by the time that clear evidence comes through, you have overshot where interest rates need to be,” Guha said.
But it remains to be seen whether the softness in economic data is pointing to an impending recession or just economic bumpiness that could eventually smooth out, he said.
This article was provided by Bloomberg News.