Traders increase bets on interest rate cuts

Traders have increased bets that the US Federal Reserve will continue to cut interest rates, after the US central bank showed a willingness to lower borrowing costs compared to expectations, especially as the Fed also raised its inflation forecast.

The Federal Open Market Committee (FOMC) kept the federal funds rate unchanged at 4.25%-4.5% for the second straight meeting, as expected by the market. The Fed also said it would slow the pace of shrinking its massive balance sheet.

However, the central bank stressed that it still needed more progress in controlling inflation and more clarity on President Donald Trump's trade policy before making a decision. This wait-and-see stance kept markets on edge, closely watching for any signs of a change in Fed policy.

The Fed has lowered its growth outlook for the world's largest economy and is expected to cut interest rates by half a percentage point this year. Illustrative photo

In updated economic forecasts, the Fed lowered its growth outlook for the world’s largest economy and projected a half-percentage-point rate cut this year, the equivalent of two quarter-point cuts. Fed Chairman Jerome Powell said the current level of uncertainty was “ extremely high .”

Fed funds rate futures are now pricing in a 64 basis point cut in December, up from 56 basis points before the Fed statement. This suggests traders are pricing in two quarter-point rate cuts and potentially one more cut this year.

There had been expectations before the meeting that the escalating trade war and rising inflation could prompt the Fed to take a more aggressive stance on inflation control, perhaps even delaying monetary policy easing. However, Mr. Jerome Powell reversed that expectation in the press conference that followed.

Tough stance declines

“ Fed chairman Jerome Powell has said that ‘we can cut rates even if there is tariff-induced inflation, if that is appropriate, ’” said Andrew Lilley, chief rates strategist at Australian investment bank Barrenjoey. “ He seems to be less of a stickler for keeping rates on hold as the risk of a recession increases .”

Asked about the possibility of a rate cut in May, Jerome Powell replied: “ I don’t think we’re going to be in a rush to act. We’re going to wait for more clarity .”

The market is currently pricing in a 23% chance of a Fed rate cut in May and a near-certain cut in July.

“ While this month’s inflation data may be at risk of being elevated, we can expect core inflation to decelerate over the summer, just in time for the Fed to cut interest rates in June, ” said Jeffrey Roach, chief economist at US-based LPL Financial.

However, tariff-related uncertainty continued to weigh on U.S. consumer confidence, sending stocks tumbling as investors rushed into safe-haven bonds. The yield on the U.S. 2-year Treasury note, which reflects interest-rate expectations, fell 6 basis points to 3.98%, while the yield on the 10-year note fell 3 basis points to 4.25%.

Pessimism towards the USD

In currency markets, the U.S. dollar index, which measures the greenback against a basket of six major currencies, edged up 0.3% to 103.511. However, it was still trading near its lowest level since October 2024, due to concerns about a possible U.S. recession. The Australian dollar held steady at around 63.54 U.S. cents after rising nearly 3% since the start of the year.

Reflecting market concerns about the world’s largest economy, the Fed cut its economic growth forecast for this year from 2.1% to 1.7%. At the same time, the US central bank also raised its forecast for core inflation – the Fed’s preferred inflation measure – from 2.5% to 2.7% this year, while the Fed’s inflation target is 2%.

Expert Jeffrey Roach from LPL Financial commented that the FED's more pessimistic growth outlook will put pressure on the USD.

While the US bond market was cautious, the Australian bond market was largely unchanged. The three-year yield held steady at 3.8%, while the 10-year yield remained at 4.42%.

Money market futures are now pricing in a total of 63 basis points of rate cuts from the Reserve Bank of Australia (RBA) this year, up slightly from 61 basis points on March 19. Trading still reflects a high probability of easing in July, with a two-thirds chance that the RBA will cut rates by 0.25 percentage points as early as May.

However, Andrew Lilley warns that bond markets may be too optimistic about the timing of a rate cut, predicting at least one cut by the RBA in the second half of the year, after last month’s first rate cut in five years.

In updated economic forecasts, the Fed lowered its growth outlook for the world's largest economy and is expected to cut interest rates by half a percentage point this year, equivalent to two 0.25 percentage point cuts.

Minh Hien

According to AFR