Expectations of May interest rate hike plunge as US inflation falls

Expectations that the Federal Reserve will raise rates again next month fell after new data showed US inflation slowed in March.

Annual headline inflation in the U.S. fell from 6 percent to 5 percent in March, lower than forecasts of 5.1 percent, while monthly inflation fell from 0.4 percent to 0.1 percent, according to the U.S. Bureau of Labor Statistics .

Just prior to the release of the data, markets had priced in a 73.8 percent chance of a 25 basis point increase in the Federal Funds Rate when the Federal Open Market Committee met on May 3.

But this fell to a sharp 66.2 percent within minutes of release, according to data from the CME Group.

With the US leading the way around the world, rate watchers in the UK will see the shift as an indication that there is less chance of more Bank of England increases in the future.

Headline inflation in the US declined more than expected in March

Markets are still seeing the Fed increase its Federal Funds Rate range from 4.75 percent to 5 percent to 5 to 5.25 percent, while 33.8 percent predicts no change.

Charles Schwab UK managing director Richard Flynn said: “Today’s drop in inflation rates is likely to be welcomed by investors, who may be speculating that the Fed may soon break its cycle of monetary tightening.

He warned that while inflation is falling, it remains well above the Fed’s 2 percent target and that the central bank may therefore “decide that additional tightening is necessary to meet its target.”

Daniel Casali, chief strategist at asset manager Evelyn Partners, said there is a risk that the Fed will “tighten policy too tight” with further rate hikes, which could lead to “a financial crisis in the banking sector.”

He added, “While there is still inflation in the economy, the Fed Funds rate is now higher than Fed forecasts of underlying inflation, and this positive real rate indicates that policy is already restrictive.

However, the Fed will be aware that there are inflationary factors beyond its control, particularly energy prices. OPEC’s recent production cut has boosted crude oil prices and made the Fed’s job of curbing inflation more difficult.

“So, despite the hawkish rhetoric from FOMC members, the Fed may be reluctant to raise rates too far.”

Markets are now pricing in 66.2% of a 25 basis point rate hike by the Fed on May 3

Casali also noted that the Fed is at odds with market expectations of interest rate cuts by the end of the year, as current futures markets indicate.

Current market prices show a 94.5 percent chance that the target rate range will fall by the Fed’s meeting in December, with a 36.3 percent chance that it will be 4.25 to 4.5 percent and a chance of 30.1 percent that it will be 4 to 4.25 percent.

In fact, markets are currently pricing an 8.25 percent chance of a range of 3.75 to 4 percent.

Isabel Albarran, investment officer at Close Brothers Asset Management, said: “While there is only one hike priced in for this year, the Fed’s already implemented tightening will take time to feed through into the economy, and we expect growth to and employment will continue to cool. .

Perhaps a better question is whether the Fed will cut as aggressively as markets expect – futures prices indicate interest rates will be 50 basis points lower in early 2024 than they are today. Growth would have to slow significantly to warrant such action.”

What about the Bank of England?

The BoE’s Monetary Policy Committee meets on May 11 and the market has almost fully priced in a 25 basis point hike in key interest rates to 4.5 percent.

Analysts at ING said: “The market prices an 80 percent chance of such an outcome, while our team thinks the BoE can stay on hold.

Speaking in Washington today, Governor Andrew Bailey will provide insight into the latest BoE thinking. There is a risk that he is hinting at a break, having seen fellow central bankers in Australia and Canada do so in recent months.”