The market data from December 23 has thrown cold water on things: investors' bets on the Federal Reserve cutting interest rates in January next year have sharply diminished, with the current probability only at 17%. This is a complete 180-degree turn compared to the previous bullish sentiment regarding interest rate cuts. What has caused such a dramatic change in market expectations?
After all, it boils down to the performance of the U.S. economy and inflation being too resilient. Initially, everyone thought the U.S. economy would cool down quickly, prompting the Federal Reserve to cut rates to save the situation. However, the reality is that while the job market isn’t as hot, there haven't been significant layoffs, and consumer spending has not collapsed. Signs of a soft landing for the economy are becoming increasingly evident, so the Federal Reserve naturally has no reason to rush into cutting rates. More crucially, inflation was expected to fall back to the 2% target, but core inflation has stubbornly remained. Rising energy prices and wages have caused inflation to decline very slowly, making it unusual for the Federal Reserve to casually cut rates.
Federal Reserve officials have been sounding the alarm. Recently, many voting members of the Fed have come out to say that the inflation risk is not yet gone, and that we absolutely cannot lower interest rates too early. Some have even stated that if the economy continues to be strong, interest rates might need to be raised. After hearing so many hawkish voices, investors are no longer daring to hold onto the fantasy of "rate cuts coming soon" and can only obediently adjust their bets.
Once expectations change, the market reacts immediately. U.S. Treasury yields are rising sharply, especially for short-term government bonds, as the expectation for rate cuts has vanished, making bonds less attractive; the U.S. dollar has also strengthened, halting its previous decline; and those growth stocks and gold that rose on the expectation of rate cuts are starting to wobble, facing pressure from valuation corrections. Even emerging markets have to become tense, as a strong dollar may lead capital to flow back to the U.S., putting both exchange rates and stock markets at risk.
However, this 17% probability is not set in stone. The upcoming inflation data and non-farm payroll reports, if one of them falls short, the market might pick up the rate cut bets again. But in any case, this expectation reversal is actually the market returning from previous blind optimism to a rational state that relies on data. For us investors, rather than guessing when the Fed will cut rates, it’s better to focus on changes in economic data, which is much more reliable than blindly following the trend.
$SOL
