Recent data releases have prompted a significant shift in market sentiment regarding the likelihood of a June rate cut by the Federal Reserve. Traders have sharply reduced their expectations, with the probability of a 25 basis point rate cut dropping to just 17.5%. This represents a dramatic decrease from the 61.1% probability seen just last week. In contrast, the likelihood of rates remaining unchanged has more than doubled, soaring to 81.8% from 37.1% last week.
The release of consumer price index data showing higher-than-expected inflation growth in March has played a crucial role in shaping market expectations. This data, which exceeded expectations for the fourth consecutive month, suggests that the recent trend of declining inflation may be coming to an end. It is now anticipated that inflation will remain well above the Fed’s 2% target in the coming months. Rising commodity prices, particularly in the fuel sector, along with robust consumer spending, have been key factors driving this uptick in inflation.
Fed Officials’ Concerns
The minutes from the Fed’s March meeting further underscored concerns about inflation persistence. Even prior to the latest inflation data release, Fed officials had expressed apprehension about the sticky nature of inflation. Some officials went as far as suggesting the necessity of maintaining higher interest rates for an extended period. Moreover, the idea of additional rate hikes was floated during discussions at the meeting.
The market reaction to these developments has been swift and pronounced. The dollar index surged to a near five-month high, while 10-year U.S. Treasury yields also reached nearly five-month peaks. In contrast, risk-driven assets, such as the S&P 500, experienced declines, with losses nearing 1% on Wednesday. Looking ahead, persistent tensions in the Middle East are anticipated to keep oil prices supported, thereby contributing to inflationary pressures.
Overall, the market’s cautious optimism in response to recent inflation data and Fed minutes highlights the delicate balance that investors and policymakers must navigate. While concerns about inflation persistence persist, the possibility of higher interest rates and delayed rate cuts looms large. It remains to be seen how these factors will play out in the coming months and how they will shape market dynamics moving forward.