Traders Are Betting Fed Will Cut Rates in 2023 After Steep Hikes

(Bloomberg) — After amping up wagers on steeper Federal Reserve hikes, traders are now turning to when the US central bank will need to cut — and piling in just as aggressively.

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Three quarter-points of cuts are expected within two years — the most since before the global financial crisis — even as money markets rush to bet on an unprecedented 75-basis-point increase this month and next, with further tightening to follow.

“We’re in the eye of the storm now, with inflation being such a key risk, but the narrative is moving to a recession and a hard landing,” said Steve Ellis, global chief investment officer of fixed-income at Fil Investment Management Limited, better known as Fidelity International. “The Fed has to be careful, there are lots of factors at play. There’s a chance they over-tighten, and then have to unwind.”

An increase of 100 basis points this week has even been mooted by some market participants to get a grip on inflation running at the fastest pace in four decades. While that’s still far from Wall Street’s base case, JPMorgan Chase & Co.’s Michael Feroli — the firm’s chief US economist — calls it “a non-trivial risk.” Feroli expects a three-quarter-point increase on Wednesday.

The rush to bet on higher borrowing rates has lifted expectations for the peak of the Fed’s tightening cycle and brought forward the timing by three months. But running in unison have been wagers on easing, with a first reduction by the end of next year, followed by a half-point of cuts by the middle of 2024, according to one-month forward swaps tied to the overnight rate.

This position stands in contrast with a Bloomberg poll of economists who expect the first cut at the end of 2024.

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“I think that is super reasonable and there is room for more, because rate cuts happen in a bunch and are hardly spread out,” said Rishi Mishra, an analyst at Futures First. “It’s usually take the stairs up and the elevator down.”

(Updates throughout.)

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