Traders Boost Bets on Super-Sized March Fed Hike on Jobs Blowout

(Bloomberg) -- Traders increased bets that the Federal Reserve will kick off its interest-rate hikes with the steepest increase in two decades after an unexpectedly strong jobs report reinforced speculation the economy is at risk of overheating.

The pricing of overnight index swaps tied to Fed meeting dates indicates a fed funds rate of around 0.44% after the March gathering, about 36 basis points above the current effective rate. That essentially means traders are giving roughly even odds to the chance that the Fed will start tightening monetary policy with the first half-percentage-point increase since 2000, instead of a typical quarter-point move.

The increasing wagers reflects the dramatic repricing that has swept through financial markets in the wake of the jobs report, which sent Treasury yields surging across the board. At the end of the day on Thursday, swaps traders were were pricing in just a 20% chance of a 50-basis-point hike at the March meeting. Further out, some 135 basis points -- or almost five and a half quarter-percentage-point moves -- are now priced in through the December Fed meeting, up 10 basis points from Thursday's close.

“The Fed will use this data to justify a 50-basis-point rate hike in March,” said Diane Swonk, chief economist at Grant Thornton LLP. “Another 25 basis points is expected by June, with a decision to start reducing the Fed's mammoth balance sheet.”

While traders are moving closer to expecting an usually larger rate increase at the March meeting, Fed officials ahead of Friday's report had been clear that such a move was not on their agenda. None of six Fed officials speaking so far this week have backed the idea of a half-point increase in March, and the most aggressive, James Bullard, the president of the St. Louis Fed, said five hikes this year -- or one more than every quarter -- is “not too bad a bet.”

Fed Won't Be Rushed in Its Hiking Path by Wall Street Frenzy

The more hawkish outlook from U.S. traders comes after the U.S. jobs data added fuel to the argument for faster tightening of monetary policy. Nonfarm payrolls increased 467,000 in January after an upwardly revised 510,000 gain in December, surprising economists who had expected a surge in Covid-19 infections to weigh on hiring. The highest estimate in a Bloomberg survey was for an increase of 250,000 jobs. Wage growth accelerated, too, adding evidence that a tight labor market may fuel inflation.

“This seals the deal for a March hike,” Ryan Sweet, head of monetary policy research at Moody's Analytics Inc., said after the employment report. “Odds of a 50 basis point hike are a little higher but still unlikely. The Fed is going to take away from this that the economy is barreling toward full employment and this will make it more difficult for them to gracefully engineer a soft landing.”

With the size of the March hike still up for debate, what is clear is that markets are continuing to cram the hiking cycle closer to the start of this year. Swaps are pricing in three rate hikes through June, suggesting one each at the Fed's meetings in March, May and June. Markets are also expecting the bank this year to start paring its massive asset holdings by not rolling over maturing bonds, removing another source of financial-market support.

“This employment report reinforces the idea that it is prudent to move away from the current regime of exceptional policy accommodation,” said Roberto Perli, a partner at Cornerstone Macro in Washington. “A March liftoff, which was already very likely, is now almost a given. And balance sheet shrinking -- or quantitative tightening --will probably follow in relative short order—about a quarter or at most two later.”