The Rate Flip

Posted by Jacob Radke

I've posted charts like these before, and they aren't exactly the easiest to read. But for the most recent data, because things are moving fast, this will have to do.

What you are looking at are stacked probabilities of the different ranges of the Federal Funds Rate for the end of the year. The larger gap between a line and the line below it means a higher probability of that being the target at the end of the year. If the range is higher than 4.75%-5.00%, then that means the market is pricing in more rate hikes, and if it is less, that means the market is pricing in cuts.

For simplicity, this is what this tells me: there was about a 90% chance of rates being at or below the current rate before February at the end of the year (a good thing for markets). Then that switched to about a 90% chance of a rate higher than current rates at the end of the year (a bad thing for markets). Then it switched back to about a 60% chance of rates being at or below current rates at the end of the year (a somewhat good, somewhat bad thing for markets).

Starting in February, we had far hotter than expected numbers on the labor market and slightly hotter than expected inflation. Those two things combined, which are what the Fed is mandated to control, caused the markets to price in higher rates, as demonstrated by the rising probabilities on the top chart and the falling probabilities on the bottom chart.

Right towards the end before the spike, you can see a fairly important move downward, virtually signaling a 0.5% hike (higher than previously expected). That happened because in Jerome Powell's testimony to Congress, he spoke of higher rates for longer. The market took that and presumed it was going to be what will happen in March, especially because that meeting is next week.

The day after his testimony, Silicon Valley Bank started to collapse, then on Friday it went under. Because the Fed has been looking for parts of the economy that are breaking, the Fed's tools are sledgehammers not feathers, the markets started pricing in lower rates and even rate cuts in the coming meetings.

Essentially, rate expectations have flip-flopped three times in the matter of a month (something that doesn't happen very often).

It's very hard to say what will happen even at the March meeting. However, it is looking like a pause or a slight increase are in the cards with the expectation of lower rates in the future.

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