The recent crazy rise in global stock markets, bond markets, and gold markets indicates that traders generally believe that the current round of interest rate hikes by the Federal Reserve has ended. The focus of debate now is when central banks will start cutting interest rates and how much they will cut.
In early trading on Monday in the Asian market, spot gold soared to $2,146.79 per ounce, approaching the $2,150 per ounce mark and hitting a new record high. Eamonn Sheridan, an analyst at financial website Forexlive, said this was because market expectations of future Fed rate cuts were stimulating investors to buy gold in large quantities.
In fact, the sharp rise in gold prices earlier today is just a microcosm of the collective surge in stocks, bonds, and commodity markets recently. Hopes for an end to Fed rate hikes have driven a comprehensive rally across asset classes since November.
The Dow Jones Industrial Average rose sharply by 2.4% last week for its fifth consecutive weekly gain and achieved its longest continuous weekly gain since late 2021. The S&P 500 also rose 0.8% for the week to its highest level since March 2022.
Persistent buying pressure in the US Treasury market pushed down yields on 10-year US Treasuries to 4.225%, their lowest level since early September. Yields on two-year US Treasury notes which are particularly sensitive to interest rate expectations saw their largest weekly decline since March – coinciding with Silicon Valley Bank’s collapse.
From pricing in the interest rate market perspective, there is no doubt about how astonishingly dovish market bets have become. As shown below over the past month or so expectations of future Fed rate cuts over three years have caused a significant downward shift across entire yield curves.
Regardless of whether the US economy achieves a soft landing or spirals into decline it seems neither scenario prevents people from believing that interest rate cuts are imminent. Currently, industry insiders have already priced in a Fed rate cut in May next year and the probability of a rate cut in March next year exceeds 50%.
Looking at the whole year, market expectations are that the Fed will cut rates by at least 125 basis points (equivalent to five 25-basis-point cuts) next year. This bet seems to have paved the way for further declines in US Treasury yields and continued rebounds in stocks, bonds, and commodity markets.
It is worth mentioning that expectations for interest rate cuts by major central banks around the world next year do not only exist with regards to the Federal Reserve. According to statistics on interest rate swap contracts from industry insiders, traders have fully priced in the following time points for first-rate cuts by various central banks:
- April next year: European Central Bank, Bank of Canada
- May next year: Federal Reserve
- June next year: Swiss National Bank, Bank of England
- August next year: Reserve Bank of New Zealand
- December next year: Reserve Bank of Australia
Market bets increasingly detached from central bank “control”
An interesting detail is that despite Federal Reserve Chairman Powell’s cautious statement before the blackout period last Friday, he still cautiously stated that it was too early to speculate when policy would ease. However, market participants betting on a shift in the Federal Reserve seem unconcerned and continue to bet wishfully that rate cuts are imminent.
Powell said last Friday that their policy setting “has moved into restrictive territory, which means monetary policy tightening” is slowing economic activity. This is the strongest signal officials have sent so far indicating they may have ended rate hikes.
But Powell’s comments also remain cautious. He said in a speech at Spelman College in Atlanta, “It is premature to conclude confidently now that we have taken enough restrictive steps.”
Powell stated that recent slowdowns in inflation and wage growth demonstrate the success of the Fed’s rate hike actions and officials expect further cooling of the economy. Therefore, although he said officials will “further tighten policy under appropriate circumstances,” he also indicated that the threshold for further rate hikes has increased. Powell’s remarks suggest officials are likely to stand pat at their December meeting while leaving open guidance for future changes more likely to be increases rather than cuts.
The Federal Reserve has raised its benchmark federal funds rate at its fastest pace in 40 years over the past 18 months. The most recent increase was in July this year when it raised rates to 5.25%-5.5%. If there is no change after this month’s third consecutive policy meeting, this interest rate range will remain unchanged until at least late January next year.
Regarding why Powell’s speech last Friday failed to change market dovish bets, Peter Boockvar, author of the Boock Report, said, “Powell tried to fight back, but the effect only lasted a few seconds in the Treasury market. The market believes that the Fed has completed rate hikes and will cut rates next year, while Powell’s speech that day was intentionally (hawkish). I believe Powell wants to keep the market cautious.”
Quincy Krosby of LPL Financial pointed out that the market firmly believes that the Federal Reserve made dovish decisions in November and will start an interest rate cutting cycle before mid-2024 (or even earlier), which contradicts slogans of higher and longer rates. She said, “Although both doves and hawks on FOMC seem to revolve around a more ‘cautious’ policy approach and acknowledge that policy is still appropriate, it is clear that the market disagrees.”
Of course, as previously calculated by Deutsche Bank, this is already the seventh time during this tightening cycle when industry insiders have bet on an early dovish shift by the Federal Reserve. The previous six attempts all ended in failure. This also raises concerns among some market participants about whether recent joint rebounds in stocks and bonds are excessive.
Mark Dowding, Chief Investment Officer at RBC BlueBay Asset Management in London, stated that after investors’ “quest for returns” in November he expects yields to rise over the next few weeks. At first we had a constructive view on bond maturities at beginning of November but with declining yields we have taken profits and turned bearish last week. We believe it is too early for markets to make forward-looking judgments about what central banks might do.
Looking ahead to this week, a series of economic data releases will undoubtedly test bullish sentiment in stock and bond markets—especially Friday’s non-farm payroll data—which is expected to bring new highs to market trends. Economists surveyed by media expect non-farm payrolls to increase from 150,000 last month to 200,000 as striking workers return to work in November. The unemployment rate is expected to remain stable at 3.9%, while wage growth is forecasted to slightly slow down to 4%.