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UPDATE 1- Investors back off view that Fed could raise rates in late 2022

05/07/2021 14:13
UPDATE 1- Investors back off view that Fed could raise rates in late 2022

New throughout

By Kate Duguid and Ann Saphir

- U.S. investors who had been betting the Fed would raise rates as early as the end of next year abruptly retreated from those positions on Friday after a disappointing April employment report and now see the earliest the Fed might tighten roughly two years away.

The push back in expectations for when the Fed might start raising rates also means any reduction in the pace of its bond buying - which the Fed has said will begin first - may also occur later than some investors had been betting.

April's employment growth came in far short of expectations, probably restrained by a shortage of workers and raw materials even as demand improved rapidly. It would be hard to argue it stands as "substantial further progress" toward maximum employment, the test the Fed has said it must achieve before it begins dialing back its massive support for the economy.nL1N2MT2XDnL1N2ML2SG

"It was a rude awakening. It could be what the Fed is worried about, that we're going to continue to see uneven numbers and it's not just going to be smooth sailing," said George Goncalves, head of U.S. macro strategy at MUFG.

Following April's meeting, investors were betting the Fed would raise rates in late 2022 or early 2023 and would offer clues about tapering its $120 million in monthly asset purchases as soon as June 2021.

U.S. interest rate futures on Friday, however, showed that traders pushed out expectations of a rate hike by roughly three months after Friday morning's payrolls report. Eurodollar futures, a proxy for interest rate expectations, showed a 90% chance of an interest rate hike in March 2023, and fully priced in a hike in June 2023. Prior to the report, investors were betting there was a 90% chance of a hike in December 2022, and a 100% chance in March 2023.

Goncalves said that "we would probably need two to three more months like this to push back tapering."

Analysts at TD Securities wrote that the data "will likely reinforce the view of most Fed officials that progress has not been 'substantial' enough to start signaling tapering."

Investors still see the Fed needing to lay out a roadmap to tapering. Rick Rieder, BlackRock’s Chief Investment Officer of Global Fixed Income, said in a note that conditions "argue for at least beginning to lay out a plan for asset purchase tapering, even if the Fed is more likely to hold off on this transition for now."

The change in interest rate expectations brings the market more in line with the Fed's dovish approach to the coronavirus pandemic recovery. Though economic data has been improving, the Fed has said it has no plans to raise rates until maximum employment is achieved.

"I don't believe this report changes the calculus of Powell or the core FOMC," said Gregory Whiteley, portfolio manager at DoubleLine Capital.

"The Fed is looking for maximum employment. They've said it will take quite a while to get there. Today reinforces that idea - although a lack of strong GDP growth does not appear to be behind today's disappointment."

Shorter-dated Treasury yields, which move with expectations of interest rates, fell in the wake of the report. The two-year yield US2YT=RR, dropped to its lowest level since March, last down 1.4 basis points to 0.143%.

Yields at the long end of the Treasury curve initially fell following the report, but quickly recovered. The 10-year yield US10YT=RR, after hitting the lowest level since March 4, retraced most of the move to last trade at 1.543%, down 1.8 basis points on the day.

Goncalves argued that the recovery in longer-dated yields was in anticipation of auctions of new 10- and 30-year bonds next week.

(Reporting by Kate Duguid and Ann Saphir; additional reporting by Gertrude Chavez-DreyfussE
Editing by Tony Chopra and Peter Graff)

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