Traders boosted expectations for the Federal Reserve to cut interest rates this year — and raised the specter of a reduction before the central bank’s next meeting — as the US administration’s tariffs ignite fears of a global recession.
Markets briefly priced in 125 basis points of easing by year end, equivalent to five quarter-point moves, overnight interest-rate swaps showed. While traders later pared that move back, the uptick has been sharp; as of last week, just three reductions were fully priced. Swaps also show a chance of almost 40% that the central bank lowers its benchmark rate 25 basis points by next week, well before the Fed’s next scheduled policy decision on May 7.
The rapid repricing reflects the fear sweeping global markets, with US President Donald Trump showing little appetite to back down on aggressive trade tariffs announced last week. He told reporters on Sunday evening to “forget markets for a second.”
The overarching reaction has been a flight to safety. At one point on Monday, the yield on the US two-year bond, among the most sensitive to monetary policy, fell as much as 22 basis points to 3.43%. The move was partly erased through the morning as the panic started to subside.
“From our perspective, it is a question of do we take some profits or let it run,” said Daniel Loughney, head of fixed income at Mediolanum International Funds Ltd. “Markets are structurally intact, at the moment. We are watching things very carefully and if Trump maintains the mantra then I suspect things will get worse.”
Emergency interest-rate cuts are highly unusual and last employed by the Fed as the coronavirus outbreak roiled markets in early 2020. Traders briefly anticipated an inter-meeting cut in August when stocks fell sharply amid an unwind of the yen carry-trade, but policymakers held firm.
Late last week, open interest in the April fed funds futures soared, with volumes Thursday ending at a record high. At least one large block trade stands to benefit from a potential Fed policy move before the next scheduled meeting, based on the expiry date of the contract.
German bonds also rallied hard Monday, sending the German two-year yield down by as much as 20 basis points to just above 1.60% — the lowest since October 2022 — before paring the move.
Recession Incoming
In recent days, JPMorgan Chase & Co. said it expects the US economy to fall into a recession this year. Chief Economist Michael Feroli sees the Fed cutting in June, with moves at each subsequent meeting through January. The bank’s chief executive officer Jamie Dimon weighed in early Monday, urging a quick resolution to the uncertainties sparked by tariffs.
Economists at Goldman Sachs Group Inc. also changed their forecasts last week, with three reductions now the base case for both the Federal Reserve and the European Central Bank.
What Bloomberg strategists say...
“The Federal Reserve may soon not have a choice but to cut rates. Tariffs raise the ugly scepter of inflation, true, but if growth turns pear-shaped, the Fed will have no choice but to prioritize the economy.”
— Ven Ram, macro strategist, Dubai.
Governments around the world are rushing to negotiate with US officials to reduce the tariffs imposed on their exports, leaving markets in freefall as traders price in the uncertainty of whether deals can be struck.
Traders have also slashed rate-cut bets for the ECB and Bank of England on expectations policymakers will have to act to shield their economies. In both cases, swaps now imply three quarter-point cuts with almost a 50% chance of a fourth by year-end.
To be sure, Fed Chair Jerome Powell made clear on Friday that he would not rush to ease rates even as turmoil erupts across markets. In a speech, he stressed that still-elevated inflation means policymakers will need to act with caution given the temporary price boost from tariffs.
Wrightson ICAP economist Lou Crandall said a chance of a cut at or before the May 7 meeting remains, in his view, below 50%, suggesting policymakers would be wary of triggering a further bout of panic.
“A pre-emptive rate cut would only be helpful if it bolstered business confidence, and that might not be the case if it were seen as a crisis response,” he wrote in a note.
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