Fed June Hike Odds Below 50% After Inflation Expectations Tumble

  • ‘There’s a kind of shock in the market,’ CIBC World says
  • Jobs report, consumer-price decline undermine faith in economy

Traders are pulling back from bets the Federal Reserve will raise interest rates in June as inflation expectations crumble.

The odds of a hike have fallen back to about 44 percent from more than 60 percent earlier this month, based on a gauge compiled by Bloomberg. Yields on federal funds futures contracts for June and July are retreating as investors scale back forecasts for a move. Two-year Treasuries, among the most sensitive to Fed policy expectations, are poised for their first two-month rally in a year.

Investors are questioning the strength of the U.S. economy and the Fed’s plan to raise rates three times in 2017 after a weaker-than-expected March jobs gain and a surprise monthly drop in consumer prices. They’re also voicing disappointment that President Donald Trump’s proposed tax cuts and infrastructure spending plans have yet to materialize.

“There’s a kind of shock in the market,” said Kazuaki Oh’E, the head of fixed income at CIBC World Markets Japan Inc. in Tokyo. “People are starting to doubt whether the Fed can raise rates” as soon as this summer.

U.S. tensions with North Korea as well as elections in the U.K. and France are added risks to the global economy.

Fed futures traders were wrong-footed earlier this year when they bet against a rate hike at the March 14-15 meeting. They priced the odds at less than an even chance as late as Feb. 24, before a flood of hawkish Fed speakers forced them to see an increase as all but certain a week later.

For now, Treasury two-year notes are also flashing warnings that the Fed will hold off in June.

The difference between two-year yields and similar-maturity Treasury Inflation Protected Securities, a gauge of trader expectations for consumer prices over the life of the debt, tumbled to 1.37 percentage points this week. It plunged from this year’s high of 2.19, suggesting traders doubt the Fed’s ability to meet its inflation target of 2 percent.

The two-year spread over the federal funds rate has narrowed to 16 basis points from 44 at the start of the year.

The Fed will probably hike once more in 2017, but no more, said Yusuke Ito, a bond manager in Tokyo at Asset Management One, which oversees about $461 billion.

“The strength of the U.S. economy has been exaggerated, especially after Trump’s election,” he said. “Things may get worse.”