Stocks, bonds slump as traders shift Fed rate-cut expectations to September

By Christine Idzelis

'Are we actually going to get the cuts in 2024?'

Markets were rattled Wednesday by a stronger-than-expected inflation report, with stocks and bonds selling off as investors questioned whether the latest data will keep the Federal Reserve from cutting interest rates at all this year.

"Are we actually going to get the cuts in 2024?" asked George Catrambone, head of fixed income for the Americas at DWS Group, in a phone interview. "Not if we continue to have data like this."

A reading on inflation in March, as measured by the consumer-price index released Wednesday, was hotter than Wall Street expected - fueling concerns that it may not be falling durably toward the Fed's 2% target. Traders in the federal-funds futures market quickly took rate cuts off the table for the Fed's June and July meetings, according to the CME FedWatch Tool.

The March inflation reading "muddies the waters" for investors trying to discern when the Fed may begin lowering its benchmark rate, said Catrambone. He worries that September suddenly looks like a "coin flip" for a potential quarter-point cut, as the inflation report has pushed out the market's hopes for easier monetary policy.

The Federal Reserve has been holding its policy rate at an elevated level in an effort to bring down inflation, which remains sticky even as it has eased significantly from its 2022 peak.

The consumer-price index showed that inflation rose 0.4% in March for a year-over-year rate of 3.5%, according to the Wednesday report from the U.S. Bureau of Labor Statistics. Core inflation, which excludes food and energy prices, climbed 0.4% last month for an annual pace of 3.8%.

Headline inflation accelerated from 3.2% in February, while the core CPI was unchanged on a year-over-year basis. That compares with a headline CPI reading as high as 9.1% in June 2022.

See: 'Stalled' disinflation is no longer 'a blip' after CPI report

In the bond market, Treasury yields surged after the CPI report. The yield on the 10-year Treasury note BX:TMUBMUSD10Y was up about 18 basis points on Wednesday afternoon at around 4.54%, while the two-year Treasury rate BX:TMUBMUSD02Y soared about 21 basis points to around 4.95%, according to FactSet data, at last check. Bond yields and prices move in opposite directions.

"It may be a while that we're in this turbulent period," said Catrambone. "I think markets are going to remain fragile" and hang on each piece of economic data and commentary from Fed officials until rate cuts eventually begin, he said. "There's a risk we may not see cuts this year at all."

See: Fed is 'not nearly as restrictive as they think'

The fed-funds futures market now shows traders largely expect the Fed will decide at its June meeting to maintain its benchmark rate at the current target range of 5.25% to 5.5%, as well as a 59% probability that it will leave it at that level in July, according to the CME FedWatch Tool, at last check.

After July, the Fed's next policy meeting is scheduled for September.

Traders are pricing in a 45.5% chance that the central bank will lower its benchmark rate by a quarter point in September, and a 34.2% probability that it keeps rates at the current target range, according to the CME FedWatch Tool, at last check. As of Wednesday afternoon, fed-funds futures also indicated a roughly 20% chance that the Fed's policy rate may be lowered to a range of 4.75% to 5%, or lower, in September.

In the meantime, Catrambone said he expects that investors will continue to consider cash as an allocation in their investment portfolios, with money-market fund assets potentially continuing to pile up after reaching record levels.

While some investors may see buying opportunities in the bond market selloff, Catrambone expressed concern about reaching too far out into the Treasury market's yield curve. He said it may make more sense to invest in durations that are within two years.

Long-term Treasurys have been punished this year as rate-cut expectations keep getting pushed further out. The iShares 20+ Year Treasury Bond ETF TLT was falling sharply Wednesday, with the fund losing 7.7% so far this year on a total-return basis, according to FactSet data, at last check.

Elsewhere in debt markets, Catrambone said he's eyeing buying opportunities in areas such as the safest portion of collateralized loan obligations, or CLOs, which buy floating-rate leveraged loans. According to Catrambone, AAA-rated slices of CLOs have yields of almost 6%.

Meanwhile, the U.S. stock market was trading sharply lower as Treasury yields jumped.

The Dow Jones Industrial Average DJIA was down 1.3% on Wednesday afternoon, while the S&P 500 SPX was dropping 1.1% and the technology-heavy Nasdaq Composite COMP was falling 1%, according to FactSet data, at last check.

The S&P 500 remains up around 8% so far this year despite its recent selloff.

"Today's slump in [the] S&P 500, following the release of a hotter-than-expected U.S. CPI report for March, underscores the U.S. stock market's vulnerability to disappointing news on inflation," said John Higgins, chief markets economist at Capital Economics, in a note Wednesday.

"Nonetheless, even though the pull-back was accompanied by a surge in short-dated Treasury yields as investors continued to pare back their expectations for monetary easing, we doubt it marks the beginning of a new trend in equity prices," said Higgins.

-Christine Idzelis

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04-10-24 1422ET

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