Bond Traders Cave to the Fed by Dialing Back Their Rate-Cut Bets

Bond traders are finally heeding one of the market’s oldest lessons: Don’t fight the Fed.

As the Federal Reserve pushed through its steepest interest-rate hikes in decades, investors consistently misjudged how far it would go, handing them steep losses in 2022 as Treasuries tumbled.

Then early last year, they wrongly wagered a banking panic would force the Fed to stop. And in December, after Chair Jerome Powell signaled he was done for good, they wagered he would pivot to easing policy aggressively, with the first rate cut coming as soon as March, even though the Fed’s forecasts showed otherwise.

But investors are now taking the central bank at its word.

In the derivatives markets, they’ve started pricing in that the Fed will carry out just four — or five at the most — quarter-point rate cuts in 2024, only slightly more than the three penciled in by policymakers. That’s a sharp shift from the end of last year, when futures traders were wagering on seven such moves, anticipating the Fed would cut rates by a full percentage point more than it was telegraphing at the time.

Of course, Fed officials could be wrong themselves on where rates are going — as happened back in 2021 — but by syncing up with them on the path of monetary policy, investors are now less likely to be caught off-guard by rate decisions. This promises to provide some stability to financial markets and potentially limit investors’ risk after three straight bruising years in the bond market.