Investors lowered interest rate expectations in response to a jump in unemployment, lower wages and worries about the collapse of the Silicon Valley bank, and most are now forecasting a 0.25 percentage point rise from the Federal Reserve this month.
Just this week, investors have been betting that the Fed will step up its pace of interest rate hikes following a string of strong economic data in February.
After the testimony of the chairman of the Fed Jay Powell Congress on Wednesday, in which he said the bank was ready to return to bigger interest rate hikes to fight inflation, the chances of a 0.5 percentage point interest rate hike in March rose to nearly 80 percent, according to CME’s FedWatch tool, which calculates probabilities based on federal funds futures. But by Friday, they were at 38 percent.
Change followed a mixed monthly employment report from the largest economy in the world. While US employers added 311,000 jobs in February – less than in January but more than 225,000 expected – the unemployment rate rose for the first time since October. The report also shows that average hourly earnings increased by 0.2 percent compared to the expected 0.3 percent, indicating less wage pressure on inflation.
“The employment report is weaker than it looks at first glance. Even though the headlines were strong, if you look at the details – wage growth, average hourly earnings – these figures give the Fed the opportunity to continue on the path of 0.25 percentage points from what the markets were expecting a few days ago. said Greg Davis, chief investment officer of Vanguard.
“There was a significant revaluation today – partly due to the number of jobs, and partly due to Silicon Valley Bank.”
Employment data will be an important part of the Fed’s calculations when it meets March 21-22. After a series of 0.5 and 0.75 percentage point hikes last year, the Fed raised interest rates by 0.25 percentage points in February. An acceleration would mean a big swing in the Fed’s policy and suggest that the peak in interest rates could be much higher than the 5.3 percent that the markets are currently estimating.
The shift didn’t just happen in March expectations, Davis noted. Earlier this week, investors had forecast a September interest rate peak of nearly 5.7%. A peak of 5.3% is now expected in June, with one to two rate cuts planned by the end of the year.
“The labor market is slowing down more slowly than expected,” said Michael Gapin, chief US economist at Bank of America. But he said: “This report does not suggest a re-acceleration of the economy. This suggests sustainability. This is a world where a 0.25 percentage point increase in interest rates is appropriate.”
Adding to the volatility on Friday was the news that Bank of Silicon Valley, a California bank that caters to venture capital and tech startups, will be shut down by regulators. The crisis at the bank led to a flight to safety in the markets as investors sold the bank’s shares and bought Treasuries.
The two-year Treasury yield, which fluctuates with interest rate expectations, has fallen 0.49 percentage points since Wednesday evening. Its move on Friday – about 0.3 percentage points – was the biggest one-day drop since 2008.
While the troubles at Silicon Valley Bank are not considered indicative of widespread systemic problems in the banking sector, they did have an impact on market expectations for the Fed.
“The SVB is adding to the anxiety of the markets,” said David Kelly, chief global strategist at JPMorgan. “Does the Fed really want to add when inflation is clearly suppressed? There is nothing in today’s data to suggest the Fed should be raised 0.5 percentage points.”
Matt Freund, co-chief investment officer at Calamos Investments, added: “When you’re pumping liquidity out of the market – and obviously the Fed is doing it – it’s affecting smaller, more fragile markets first.”
According to Freund, this manifested itself in the collapse of the crypto market, which destroyed the crypto-focused banks. Silvergate this week and is now showing up in places like Silicon Valley Bank, which is more open to venture capital.
“This could be another sign that the Fed has gone far enough,” Freund said.