Expectations of May interest rate hike plunge as US inflation falls

Expectations that the Federal Reserve will hike interest rates again next month fell after fresh data showed US inflation slowed in March.

Annual US headline inflation fell from 6 to 5 per cent in March, lower than forecasts of 5.1 per cent, as monthly inflation fell to 0.1 per cent from 0.4 per cent, according to the US Bureau of Labor Statistics.

Just prior to the data’s publication markets had priced a 73.8 per cent chance of a 25 basis point hike in the Federal Funds Rate when the Federal Open Market Committee meet on 3 May.

But this fell to sharply 66.2 per cent within minutes of the release, CME Group data shows. 

With the US setting the tone around the globe, ratewatchers in the UK will see the shift as indicating less chance of more future Bank of England rises too.

Chair of the Federal Reserve board Jerome Powell 

US headline inflation softened more than expected in March 

Markets still see the Fed hiking its Federal Funds Rate range from 4.75 per cent to 5 per cent to 5 to 5.25 per cent, while 33.8 per cent predict no change.

Managing director of Charles Schwab UK Richard Flynn said: ‘Today’s fall in the rate of inflation is likely to be welcomed by investors, who may speculate that the Fed could soon pause its cycle of monetary tightening.

He cautioned that while inflation is falling it remains well above the Fed’s 2 per cent target and the central bank therefore ‘may decide that additional tightening is required to achieve its target’.

Chief investment strategist at wealth manager Evelyn Partners Daniel Casali said there is a risk the Fed ‘overtightens policy’ with further rate hikes, which may lead ‘to a financial crunch in the banking sector’.

He added: ‘Although there are still pockets of inflation in the economy, the Fed Funds rate is now higher than Fed forecasts of underlying inflation, and this positive real interest rate indicates that policy is already restrictive.

‘However, the Fed will be aware that there are inflation drivers that are outside of its control, particularly energy prices. OPEC’s recent production cut has given a boost to crude oil prices and complicates the job of the Fed to bring down inflation. 

‘So, despite the hawkish rhetoric from FOMC members, the Fed may be reluctant to raise rates too far.’

Markets are now pricing in a 66.2% of a 25bps Fed hike on 3 May 

Casali also noted that the Fed is at odds with market expectations of rate cuts by the end of the year, as future markets current indicate.

Current market pricing shows a 94.5 per cent chance the target rate range will fall by the Fed’s December meeting, with a 36.3 per cent chance it will be 4.25 to 4.5 per and a 30.1 per cent chance it will be 4 to 4.25 per cent.

Markets even currently price an 8.25 per cent chance of a 3.75 to 4 per cent range.

Isabel Albarran, investment officer at Close Brothers Asset Management, said: ‘While only one more hike is priced in for this year, the Fed’s already-executed tightening still needs time to feed into the economy, and we expect growth and employment to cool further.

‘A better question is perhaps if the Fed will begin cutting as aggressively as the markets expect – futures pricing indicates rates will be 50bps lower at the start of 2024 than they are today. Growth would need to slow significantly to justify such action.’

What about the Bank of England?

The BoE’s Monetary Policy Committee will meet on 11 May and the market has almost fully priced a 25bps base rate hike to 4.5 per cent.

Analysts at ING said: ‘The market prices an 80 per cent chance of such an outcome, while our team thinks the BoE could stay on hold.

‘Providing insights into the latest BoE thinking will be Governor Andrew Bailey, who speaks in Washington today. There is a risk that he hints at a pause, having seen fellow central bankers in Australia and Canada do so over recent months.’

This post first appeared on Dailymail.co.uk