Two- and five-year Treasury yields climbed to the highest levels this year as swaps traders and economists at Goldman Sachs Group Inc. forecast fewer Federal Reserve interest-rate cuts.
The US two-year yield reached 4.749%, the highest level since December 11, before paring the advance and ending the session little changed. The yield on the five-year note touched 4.367%, the highest since November 28.
At one point Monday swap contracts that predict decisions by the US central bank put the odds of a June rate cut at less than 50%. The contracts would ultimately finish the day lower, reflecting expectations that a rate cut by the June meeting was slightly more likely than not. The Fed has kept its benchmark rate in a range between 5.25% and 5.5% since July.
“There is still way too much liquidity out there,” Michael Contopoulos, director of fixed income at Richard Bernstein Advisors, said. “Financial conditions are easing, credit is flowing freely, unemployment is low and inflation is stubborn, earnings growth is accelerating and speculation is rampant. This is not an environment conducive to cutting interest rates.”
Swap traders also penciled in a total of 69 basis points of reductions for the year, fewer than the three quarter-point cuts suggested by the median Fed official projections at the December policy meeting.
It points to an increasing risk that Fed officials may revise their projections to imply fewer cuts when they conclude a two-day meeting on Wednesday, as inflation and growth data have come in better than expected. It would take only two policymakers switching to two cuts this year from three for the central bank’s median forecast to move higher.
“Arithmetically, it is very easy for the dots to move from three to two,” said Lindsay Rosner, head of multi-sector fixed income investing at Goldman Sachs Asset Management. “Market is pricing that recent inflation prints may have tilted the Fed to push their cuts later in the year as they are trying to garner more confidence.”
Late Sunday, economists at Goldman Sachs changed their forecast for Fed monetary policy to call for three quarter-point interest-rate cuts this year instead of four, “mainly because of the slightly higher inflation path.”
The economists, led by Jan Hatzius, continue to expect the first rate cut in June, four cuts in 2025 and a final one in 2026, leaving their forecast for terminal rate unchanged at 3.25%-3.5%.
While the economists acknowledged that Fed officials may be becoming “less convinced that inflation will resume its earlier soft trend,” they still see policy makers start the easing cycle in June to mitigate the risk of keeping rates too high for too long.
“We suspect that the Fed leadership shares our view that the hard part of the inflation fight is over and would still prefer to get at least some rate cuts in sooner rather than later to minimize the risk that some unforeseen problem arises, such as a financial stability problem triggered by the shift to sharply higher interest rates than were anticipated a few years ago,” they wrote in a March 17 note.
