Here’s What Markets Are Now Saying About Fed Rate Hikes This Year

The outlook for what the Federal Reserve is likely to do on interest rates continues to evolve as Kevin Warsh settles into his new role as Fed chair, inflation moves up and down, and new government data is published on both inflation and the labor market.

But at the moment, futures traders and the bond market expect at least two quarter-point rate hikes by the end of this year, and perhaps as many as four.

If you look at pricing in the federal funds futures market, an excellent way to gauge the collective outlook for the Fed’s target interest rate, it suggests the odds of two or more quarter-point hikes this year are 61%. That market puts the odds of just one quarter-point cut at about 32%, and the likelihood the Fed will keep the target rate where it is now through the end of the year at 7%.

If we amble over to the bond market, we can check the two-year Treasury yield. That particular yield is most sensitive to the Fed’s target rate, so it indicates the collective wisdom of bond traders as to where that rate is heading in the near future.

Right now, the yield on the two-year is 4.33%. That’s 0.7 percentage points above the effective federal funds rate, which stands at 3.63% right now. That indicates that bond traders expect that rate to rise about 0.7 percentage points in the coming months, which is almost three quarter-point rate cuts.

Energy prices are moving the inflation data

What’s driving those markets to believe that multiple rate hikes are likely this year?

Image source: Getty Images.

Well, the June Consumer Price Index, which was published on July 14, indicated that inflation fell last month. But when you dig into it, it becomes clear that most of that drop was due to a huge drop in energy costs, particularly the cost of gasoline.

And since the U.S.-Iran ceasefire collapsed earlier this month, energy costs have soared again. Brent crude, the international benchmark, is back above $96 a barrel (it briefly topped $100 a barrel last week). And gasoline in the U.S. is also rising again.

Finally, all recent data about the labor market suggests it is chugging along very nicely, which means Warsh and his colleagues are likely to set policy in the coming months with a focus on their mandate to keep inflation low and stable.

Warsh himself said so in recent testimony before Congress, telling committees in both the House and the Senate that “high inflation has been an undue burden on American households and businesses” and that, if the Fed gets its policymaking right, “the inflation surge of the last five years will be a thing of the past.”

Thus, rate hikes in the coming months look very likely. But don’t trust me on that. Just ask the futures and bond markets.