Options traders see rising risk of Fed rate hike following oil rally, solid U.S. data

By Vivien Lou Chen

Signs of a reaccelerating U.S. economy have 'rekindled the risk that central banks will have to lean more hawkish than expected,' Barclays team says

A combination of healthy U.S. economic data and a rally in oil is renewing the risk of what one major Wall Street bank calls a "hawkish negative surprise" by the Federal Reserve and other central banks. In a note on Wednesday, a team of strategists at Barclays (UK:BARC) said rates markets are now positioned for the possibility of fewer rate cuts than the three quarter-percentage point reductions projected by the Fed.

Meanwhile, the options market sees a much higher chance than it did in February and early March that short-term borrowing costs will be higher by year-end than the current level between 5.25% and 5.5%.

In other words, parts of the financial market are bracing for the possibility the Fed's recent rate-cut projections may be off and that policymakers might even need to hike again by December, which would likely usher in more volatility across assets.

Signs of persistent U.S. inflation in this week's data, for example, produced a reflation trade on Tuesday that led to a tandem selloff in stocks and government debt; a rally in gold and silver; a spike in the U.S. Dollar Index; and a rise in crude oil, which finished at the highest level since late October.

"Signs of a reaccelerating economy in the U.S. have recently pushed back against the Goldilocks narrative, and rekindled the risk that central banks will have to lean more hawkish than expected. This has been reflected by short-rate markets," said Barclays strategists Stefano Pascale, Anshul Gupta, Riddhiman Dass, and Tejas Shah.

Their views came as investors assessed remarks on the U.S. economic outlook from Fed Chairman Jerome Powell, who stuck by the message that there is no rush to cut rates and it's too soon to say if recent higher-than-expected inflation readings are more than just bumps.

On Wednesday, oil futures finished higher for a fourth straight session, while 10- BX:TMUBMUSD10Y and 30-year Treasury yields BX:TMUBMUSD30Y ended at or near their highest levels since November. U.S. stocks DJIA SPX COMP closed mixed, with the Dow Jones Industrial Average ending lower for the third straight session.

-Vivien Lou Chen

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04-03-24 1607ET

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