Market Extra: Traders pare back expectations for Fed rate hikes in 2022 as economy contracts by more than expected in first quarter


Fed-funds futures traders are pulling back on their outlook for continued rate hikes as revised data released on Thursday shows the U.S. economy contracted by a deeper-than-expected 1.5% annual pace.

After the data release Thursday morning, traders placed a 60% chance on the fed-funds rate target getting between 2.5% and 2.75% by December, up from 35% a week ago, according to the CME FedWatch Tool. The likelihood that policy makers would get to a target between 2.75% and 3% by year-end, from a current level between 0.75% and 1%, dropped to 27% from 51% on May 19.

Accompanying the drop in first-quarter GDP was the first decline in corporate profits in five quarters — which analysts saw as a sign that the economic contraction was more real than first thought after being chalked up to a record trade deficit.

Investors have been focused on how much the Federal Reserve will need to tighten to bring down inflation running at a four-decade high, while questioning whether they’ll be forced to scale back their efforts due to a possible economic slowdown. Major U.S. stock indexes SPX, +1.75% COMP, +2.18% were up in morning trading, with Dow industrials DJIA, +1.51% rising more than 400 points amid reduced Fed rate expectations. Meanwhile, most Treasury yields were lower as growth concerns weighed on the bond market, with the 10-year rate TMUBMUSD10Y, 2.771% below 2.75%.

Minutes of the central bank’s May 3-4 meeting, released Wednesday, showed that most policy makers felt 50 basis point rate hikes would likely be appropriate at the next couple of meetings. Also, a number of participants suggested price pressures “may no longer be worsening.”

The minutes “came and went without much fanfare, and failed to inject much life into afternoon markets” on Wednesday “or the debate around the near-term path of policy,” a team at Deutsche Bank DB, +1.32% said in a note Thursday.

“With the minutes not living up to hawkish fears alongside growing concerns about a potential recession, investors continued to dial back the likelihood of more aggressive tightening,” Deutsche Bank research analyst Henry Allen and others wrote Thursday. “We’ve taken out nearly a full 25bp hike by now, which is the biggest reversal in monetary policy expectations this year since Russia’s invasion of Ukraine began.”

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