Again, Markets Are Caught Off Guard By The Fed's Imminent Rate

One of the factors contributing to another abrupt readjustment in the financial markets regarding interest rate path was a combination of the remarks of two Federal Reserve officials, strong bank earnings reports, and a rebounding consumer sentiment reading. These factors all contributed to the financial market's abrupt change in expectations. 

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It was believed that the Federal Reserve might be nearing the end of its yearlong rate hike cycle as a result of this sudden readjustment. As the ICE U.S. Dollar Index soared, the yields of Treasury securities jumped alongside it, led by a 19 basis point jump in the 1-month T-bill rate -- leading to a drop in all three major US equity indexes. 

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As a result, traders of Fed funds futures have boosted their expectations of Fed rate hikes in May and June, as well as reduced their expectations of Fed rate cuts later this year. According to Steve Englander, Standard Chartered's head of global G10 FX research and North American macro strategy in New York, everything the market had believed as of the close yesterday was contradicted today. 

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Messages from Mr. Bullard proved the contrary when he said, "Everything went wrong in the 'Fed is going to stop soon' trade," although any future spillover from the banking stress could have the potential to curtail the rate hike cycle that policymakers are in the habit of making.

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Among the data released by the Federal Reserve on Friday was a report from the University of Michigan, which showed that consumer sentiment was on the rise and Americans were more concerned about high inflation levels. While the retail sales in March fell much more than expected, Englander noted that some people believe that there is still a possibility of even deeper weakness yet to come. In addition to this, JPMorgan Chase (JPM) and Citigroup Inc. (C) reported results that satisfied investors in their first quarters.

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For the year so far, JPMorgan Chase stock has moved in a positive direction after posting earnings and revenue that exceeded expectations for the first quarter. However, two Fed policymakers have chimed in with hawkish comments in response to the reports. Despite recent inflation data showing that the central bank has not yet stopped raising rates, Fed Gov. Christopher Waller is convinced that it will continue to raise rates, while Atlanta Fed President Raphael Bostic has told Reuters the data "supports moving one more time." 

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Due to this situation, the Fed funds futures market was anticipating a quarter-point increase in interest rates in May, which would raise the Fed's main interest rate target to between 5% and 5.2%, and according to the CME FedWatch Tool, they are predicting a similar rate hike in June in a matter of months, compared with 4.7% just a day earlier.

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As Rob Daly, the director of fixed income at Glenmede Investment Management in Philadelphia, pointed out to me, "The million-dollar question is how much more is the Federal Reserve required to do?" I am of the belief that one or two more hikes will be required before the rate gets lowered. The next question is how long they will keep the interest rate at that level.

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Daly said via phone that risk assets have remained very resilient, the labor market has been very strong, and the rate of inflation continues to be high. There is no reason I believe the Fed will cut rates anytime soon. The data has been strong enough for it to remain on hold, but not necessarily weak enough to change their direction."

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