Fed Cuts Fewer Rates Than Market, Deepens Losses

Last week, there was a fleeting moment of alignment between the market and the Federal Reserve regarding the pace of monetary easing. However, this harmony didn't endure, and now Treasury investors are feeling the repercussions.

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Despite adopting a notably dovish stance earlier this year compared to Fed officials, investors have now reversed course. They are anticipating approximately 65 basis points of rate reductions in 2024, slightly less than the 75 basis points suggested by the median estimate of projections released following the Fed’s March 19-20 meeting.

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This reassessment is prompting investors to seek higher rates of return on US government bonds. Yields on Treasury securities maturing between five and 30 years surged to their highest levels of the year on Tuesday. The 30-year yield surpassed 4.5%, while the benchmark 10-year note climbed nearly 20 basis points over the past two days, marking its most significant increase since early February.

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Benoit Gerard, a rates strategist at Natixis in Paris, remarked, "I thought it would be hard for the market to challenge the Fed on the hawkish side, but apparently it is willing to do so, in the face of some evidence."

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Traders are responding to recent economic indicators that suggest strength in the US economy, potentially diminishing the necessity for rate cuts. Despite Tuesday's reports on job openings and factory orders surpassing expectations, they had minimal impact on already elevated yield levels. Key employment data for March is anticipated on Friday.

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The surge in yields gained momentum starting last Friday, when US markets were closed. February's income and spending data indicated ongoing robust consumption. Additionally, on Monday, a measure of US manufacturing activity expanded for the first time since 2022, surpassing all estimates in a Bloomberg survey of economists.

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Fed Chair Jerome Powell, commenting on the consumption data, stated that the figures were "pretty much in line with our expectations" and reiterated that the US central bank isn't rushing to cut interest rates.

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No Fed ratesetter has publicly addressed monetary policy since Monday's news. However, several are scheduled to speak later on Tuesday, including New York Fed President John Williams, Cleveland Fed President Loretta Mester, and San Francisco Fed President Mary Daly.

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This recent challenge to the Fed's outlook by traders isn't an isolated incident. In the days leading up to the March rates decision, they were also anticipating fewer than 75 basis points of easing, although this time around, the pricing reflects an even more hawkish sentiment.

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Moreover, this shift is raising doubts about predictions of the first rate cut occurring in June. The likelihood of a quarter-point reduction in June briefly dipped below 50% on Monday.

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"While June is not off the table, market conviction for a first Fed cut by then is fading," noted ING strategists including Benjamin Schroeder in a recent analysis. "In the coming weeks, we can expect some Fed speakers to remain vocal about June cuts, but in the end, the data will be the deciding factor."

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