Fed Traders Are Fully Pricing In Another Rate Hike Once Again

The shift came as US rates rose across the board, led by the front end, fueled by increased optimism.

The Marriner S. Eccles Federal Reserve building in Washington, D.C., U.S., on Saturday, June 26, 2021. The Federal Reserve might consider an interest-rate hike from near zero as soon as late 2022 as the labor market reaches full employment and inflation is at the central bank's goal.

Traders are now fully pricing in another quarter-point interest rate increase by the Federal Reserve within the next two policy meetings and a more than one-in-two chance that it could be as soon as next month.

The shift came as US rates rose across the board, led by the front end, fueled by increased optimism about a potential deal on the debt ceiling and economic data.

As recently as the first week of May, when the central bank raised rates for the tenth straight time, the market had near-total confidence that there would be no additional hikes this year, and that the Fed would cut rates as many as three times by year-end.

That view, which was based on recession risk posed by a spate of regional bank failures and indications from some policy makers, has been overtaken by concerns about persistently high inflation globally and tight labor-market conditions that predominated earlier in the year. The threat of contagion in the banking system has ebbed, and the fracas around the debt ceiling has yet to unleash haven demand that could pull expected rates lower.

The rate on swap contracts linked to the July gathering climbed to 5.34% on Thursday, more than 25 basis points above the current effective fed funds rate of 5.08%. The Fed tends to move in multiples of 25 basis points, so that indicates such a move is seen by the market taking place either in July or at the Federal Open Market Committee’s next meeting in June. The June contract showed around 14 basis points priced in, suggesting a better than even chance the move would be at that meeting.

Contracts further out continue to suggest the Fed will need to cut again within the coming year, but the extent of anticipated easing is considerably less than it was.  

The two-year Treasury yield rose as much as 15 basis points to 4.52%.

“I thought we made some progress” in debt-ceiling talks that had negotiators working past midnight on Wednesday, House Speaker McCarthy told reporters Thursday morning. “There are still outstanding issues. I’ve directed our team to work 24/7 to solve this problem.”

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