As the Federal Reserve is about to announce its latest interest rate decision, market disagreements over the future direction of monetary policy are increasingly widening. On the one hand, investors generally expect the Fed to keep interest rates unchanged at this week’s policy meeting; on the other hand, Wall Street has shown completely different judgments on whether to cut or raise rates in the coming months. From trading in bond and interest rate derivatives markets, some investors are currently betting on rate cuts next year, while other funds have begun positioning for rate hikes within this year, with the market clearly “divided” on the future rate path.
The market broadly believes that it is almost a foregone conclusion that the Fed will stand pat at the policy meeting concluding on Wednesday. Compared with the rate decision itself, investors are more focused on the first press conference to be held by new Fed Chairman Warsh after the meeting. Since Warsh just succeeded Powell as Fed Chairman last month, the market still lacks sufficient understanding of his policy style. Mark Cabana, head of U.S. rates strategy at Bank of America, said: “The market currently lacks a clear consensus, largely because Warsh remains a relatively unfamiliar figure to investors.” He believes that current market pricing actually reflects a state in which various different views coexist simultaneously.
The recent market environment has seen notable changes. The United States and Iran plan to formally sign an interim peace agreement in Switzerland this Friday, pushing international oil prices to near three-month lows. The pullback in energy prices has eased market concerns over continued inflation rises, and has also led some investors to revisit the possibility of future rate cuts. While bond traders and other Wall Street peers are betting on rate hikes, Andrew Hollenhorst, chief U.S. economist at Citigroup (C), insists that with a weakening labor market and falling oil prices, the Fed will cut rates three times this year.
Hollenhorst pointed out that falling energy prices will provide room for Fed Chairman Warsh to adopt a dovish stance at this week’s policy meeting. He indicated that inflationary pressures have now reversed and transformed into deflationary pressures. Hollenhorst expects that central bank officials will remove language regarding easing bias from the policy statement and release a forecast showing no rate cuts this year. However, Citi’s baseline scenario remains that the Fed will begin cutting rates in September, provided that the labor market continues to weaken in the coming months. He added that if this does not materialize, the timing of rate cuts could be delayed until 2027.
Nevertheless, the market has not formed a consensus on this basis. Many investors believe that even with falling oil prices, the U.S. economy and job market remain strong, and the Fed may still further tighten policy. Over the past week, options trading volume related to Fed rate expectations surged significantly, at one point 50% above normal levels, but the new trades were not concentrated in any single direction. Jeff Schuh, head of rates trading at Constitution Capital, said: “The market has not given up on rate-cut expectations, but rather believes that rate cuts may take longer to materialize.”
Not only are market traders divided, but major institutions also show vast differences in their forecasts for future rate trajectories. Compared with Citi’s dovish stance, some institutions’ projections are more “hawkish.” PGIM projected this week that the Fed may raise rates three times consecutively this year. BNP Paribas, meanwhile, expects the Fed to start raising rates in December and accumulate three rate hikes. Such wide forecast divergence reflects that the U.S. economy is currently at a critical turning point, and policymakers face a more complex balancing act.
