Fed Traders Price In 100 Basis Points of Rate Cuts From May Peak

(Bloomberg) — Government debt yields plunged globally as mounting financial-stability concerns prompted bond traders to abandon bets on additional central-bank rate hikes and begin pricing in cuts by the Federal Reserve.

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Investors priced in a drop of more than 100 basis points in the US policy rate by year-end and downgraded the odds of additional hikes by the Bank of England and the European Central Bank. The latest rout in bank shares globally has unleashed historic demand for government debt and other havens.

In the US, two-year Treasury yields plummeted as much as 54 basis points to 3.71%, the lowest level since mid-September, while German two-year rates fell as much as 51 basis points to 2.39%, heading for a record drop. Longer-maturity yields also tumbled, with the US 10-year falling as much as 31 basis points to 3.38%, approaching its January low.

The expected peak for the Fed policy rate slid to about 4.8%, with a quarter-point hike at next week’s policy meeting deemed a coin toss. The Bank of England is seen holding pat next week, and a quarter-point hike by the European Central Bank at its meeting tomorrow is favored, down from a half-point last week.

“The fear is such that it’s overwhelming everything,” said Ed Al-Hussainy, a rates strategist at Columbia Threadneedle Investments. US Treasury yields below the Fed’s current policy rate band of 4.5%-4.75% is “a strong signal the market is capitulating to an easing cycle.”

The Fed’s expected year-end rate has fallen to about 3.6%, more than a percentage point lower than the expected peak.

The thinking is that stress in the global banking system — which exploded into the open in the past week with the failure of three US institutions and continues to sink share prices for large financial companies globally — will test the Fed’s resolve to raise rates further to get inflation under control.

The repricing of Fed wagers occurred as a flight-to-quality bid swept through short-dated Treasuries, spurred by steep declines for European and US stocks. The catalyst was the latest slump in Credit Suisse Group AG shares after a top shareholder ruled out additional assistance to the Swiss bank.

“I think they should pause,” Bob Michele, chief investment officer of JPMorgan Asset Management, said on Bloomberg Television, referring to next week’s Fed meeting. “I think hiking rates — either the ECB hiking rates this week or the Fed hiking rates next week — has the potential to be the greatest gaffe since the ECB hiked rates in June 2008” during the global financial crisis.

Mixed economic data in the US morning gave pricing a further push, with a gauge of producer prices coming in slower than anticipated and a measure of New York manufacturing falling more than expected.

–With assistance from Liz Capo McCormick.

(Updates yield levels.)