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Contrarian bet emerges that next Fed move is higher, not lower – The Business Times

by Stephanie Irvin
in Real Estate
Contrarian bet emerges that next Fed move is higher, not lower – The Business Times
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IT’S at best, a longshot, but one that’s emerged among a group of die-hard bond traders – that the US Federal Reserve’s next move on interest rates will be up, not down.

The wager, which arose after a blowout jobs report on Jan 10, stands in stark contrast to the consensus on Wall Street for at least one rate cut this year. That contrarian bet has remained in place even after a benign inflation report on Wednesday (Jan 15) strengthened the Fed’s rate-cutting stance and caused yields in the US Treasury market to retreat from multi-year highs.

Based on options linked to the Secured Overnight Financing Rate, traders currently see about a 25 per cent chance that the Fed’s next move will be to lift rates by year end, according to an analysis by Bloomberg Intelligence as at Friday’s close. Those bets were as high as 30 per cent before the consumer price data. Up until over a week ago, a hike was not even entertained – 60 per cent of options traders were betting on more Fed cuts and 40 per cent for a pause.

As with so many things in financial markets these days, it’s effectively a bet on soon-to-be president Donald Trump’s policies. And it hinges on the idea that tariffs and other policies imposed by the new administration will trigger a bounce back in inflation that forces the Fed into an embarrassing about-face.

Phil Suttle, a former New York Federal Reserve economist who now runs his namesake advisory shop, sees the Fed hiking rates in September. “I have them not cutting at all. And that’s not a mad dog view,” he said on Friday.

Suttle expects Trump, who takes office Monday, to push through tariffs and restrict immigration, thus lifting inflation. The US is already starting to see wages pick up again, he said.

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For now, Suttle’s view remains extreme. Bond traders have fully priced in a quarter-point rate cut for this year and saw roughly 50 per cent of a chance for a second reduction, compared with just one cut a week earlier. On Thursday, Fed governor Christopher Waller said policymakers could lower rates again in the first half of 2025 if inflation data continue to be favourable.

The remarks pushed US government bond yields lower. Earlier last week, the benchmark 10-year Treasury peaked at 4.81 per cent, the highest since late 2023. Long-term yields have been increasing since the Fed began cutting rates in September.

“If you were to see substantial inflation surprises over the coming months, you could have a market that starts to flirt with the potential for a rate hike this year,” said Roger Hallam, global head of rates at Vanguard.

Following the December policy meeting, chair Jerome Powell said to reporters that the central bank was not willing to settle for inflation above their 2 per cent target. When asked if that meant they could not rule out a rate increase in 2025, he said, “You don’t rule things completely in or out in this – in this world.” Though he added that a hike “doesn’t appear to be a likely outcome”.

While the bar for rate hikes is high, the Fed has quickly reversed course before. In 1998, officials cut rates three times in rapid-fire succession to short-circuit a financial crisis brought on by the Russian debt default and the near-collapse of hedge fund Long Term Capital Management. The Fed then began increasing rates in June 1999 to contain inflationary pressures.

“What the market would need to meaningfully price in hikes is for inflation to really pick up again – with say headline consumer prices moving to the mid-3 per cent level,” said Tim Magnusson, chief investment officer at hedge fund Garda Capital Partners. “I think the Fed is very comfortable sitting on their hands for a while.”

Benson Durham, head of global asset allocation at Piper Sandler and former Fed economist, sees just under a 10 per cent probability priced into money-market options for at least one rate-hike this year, when the contracts are adjusted for term premium, the extra yield that investors are thought to demand for buying longer-term securities, an analysis he said the Fed has also long used.

“Overall, it seems the market is pretty balanced in seeing risks now of hikes or cuts,” he said. BLOOMBERG

Tags: BETBusinessContrarianemergesFedHigherMoveTimes
Stephanie Irvin

Stephanie Irvin

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