Expectations for rate hikes have become ever more front-loaded in the US, with seven seen for this year. But markets now suggest just one hike is on the cards in 2023. There is now an 84% probability of a rate cut priced in for 2024. That’s a big change from just the beginning of this month when they suggested zero chance of a rate cut all the way through 2025. The thinking behind the move is around how aggressive the US Federal Reserve may need to be to combat inflation with the likely consequence it could push the U.S. economy into recession.
Chart 1: A rate cut priced in for the US
Just how many rate hikes should we expect from the US Federal Reserve? History has shown the rate hike cycle tends to end when the target rate, the Fed Funds rate, reaches the yield on offer on the 5-year Treasury bond. While that yield is currently sitting at 1.6%, we should expect it to rise further once the central begins to tighten policy. A re-alignment of the two yields historically signalled an end to further rate hikes.
Chart 2: How many rate hikes in the US?
Australian bond yields are likely to retain an upside bias despite a weaker than expected reading on wages growth for the December quarter. RBA Governor PhilLowe has admitted it was plausible the RBA would have to hike this year. He also stressed the central bank can take its time because inflation in Australia is nowhere near as hot as in the U.S. Despite this, the bond market is pricing in an aggressive rate hike cycle for Australia with 2-year yields rising sharply.
Chart 3: Australian 3-year bond yield (%)