Of course, Fed officials could themselves be wrong about where rates are moving – as has happened in 2021 – but by locking in with them on the path of monetary policy, investors are now less likely to be caught off guard by rate decisions. This promises to bring some stability to financial markets and potentially limit investor risk after three consecutive difficult years in the bond market.
“Clearly we’ve gotten the message from the Fed that they want to cut insurance because they see inflation coming down,” said Ari Bergmann, founder of New York-based Penso Advisors, referring to the The central bank’s interest in ensuring that its policy does not decline. remain so strict that they block the economy.
“I think the market is now properly valued.”
The Fed’s direction will depend on whether inflation continues to decline, so the outlook could change.
But Mr. Powell made clear that he welcomed solid economic growth as long as it did not put upward pressure on consumer prices. There is little sign of that: Economists predict the Labor Department will announce Tuesday that the consumer price index rose 2.9 percent in January from a year earlier, the weakest increase since March 2021.
More room to maneuver
This regular withdrawal gives the Fed room to reduce interest rates simply to make its policy less restrictive and prevent it from exerting too much of a brake on the pace of the economy.
That expectation has helped establish a floor for the bond market, given the widespread consensus among investors that yields are unlikely to return to last year’s highs.
That sentiment was evident in the strong demand at last week’s record $42 billion auction of 10-year Treasury bonds. At the same time, options traders bet that the Treasury market would hold in a stable range pending the Fed’s first decision, which is not expected until May at the earliest.
“The Fed has three cuts for this year and the market has almost five, so directionally the market agrees with the Fed,” said Michael Cudzil, portfolio manager at PIMCO.
The gap is not wide enough to create the risk that Fed officials will try to revise expectations, especially given the uncertainty among them over when the key rate will end the year. While most Fed officials predicted between two and four cuts, with a median of three, they ranged from six to none.
Benson Durham of Piper Sandler, a former economist at the US central bank, said his model showed that prices in the options market were fairly well aligned with the Fed’s projections.
A separate study tracked by the Atlanta Fed showed last week that options tied to the overnight funding rate indicated that traders placed about the same odds that policymakers would adopt no more than four cuts by a quarter of a point in 2024. At the start of the year, the probability on this amount, only a third, the market expects a faster pace of easing.