Why does Wall Street expect a rate hike in June?

2023-05-28 20:17

Wall Street expects the Federal Reserve to raise interest rates in June. Not only that, it finally believes the central bank when it says it likely won't cut rates this year.

Why does Wall Street expect a rate hike in June?

Wall Street expects the Federal Reserve to raise interest rates in June. Not only that, it finally believes the central bank when it says it likely won't cut rates this year.

What happened? Two key pieces of economic data came in hotter than expected last week, raising investors' hackles about what the Fed's interest rate trajectory could look like:

Gross domestic product, the broadest measure of economic output, rose at an annualized rate of 1.3% in the first three months of the year, up from an initial estimate of 1.1% reported in April. The Personal Consumption Expenditures price index increased 4.4% for the 12 months ended in April, up from a 4.2% increase in March, according to fresh data from the Commerce Department.

The economic data — along with recent calm in the regional banking sector after First Republic's collapse earlier this month — has investors betting that the Fed could hike rates next month, says Mark Heppenstall, chief investment officer at Penn Mutual Asset Management.

Futures traders expected a roughly 66% chance of a quarter point rate hike in June as of Friday afternoon, according to the CME FedWatch Tool. That would mark the central bank's 11th consecutive rate increase.

Perhaps even more surprising, markets no longer believe the Fed will cut rates in 2023. That's a drastic about-face from even earlier this month, when Wall Street expected the central bank to slash rates multiple times this year starting as early as this summer.

The good news: While a strong economy does give the Fed more leeway to raise rates, it also means the US is remaining resilient in the face of the central bank's aggressive campaign to tame inflation.

Of course, the economy's strength is nothing new. Some investors who previously expected a recession have in recent months seen more indications that the economy could enter a Goldilocks scenario, where both inflation and economic growth are modest, says Peter Essele, senior vice president of investment management and research for Commonwealth Financial Network.

Moreover, the bond market is showing some signals that traders are easing their bets on a possible recession later this year. The 2-year Treasury yield is at its highest level since early March, before the failures of regional lenders Silicon Valley Bank and Signature Bank sparked fears of a recession and sent the yield sharply downward.

What's next? There are still several important economic readings that the Fed will parse before its next interest rate decision on June 14. The May jobs report is due next Friday at 8:30 a.m. ET, and early estimates from economists show job gains of 180,000 and a tick up in the unemployment rate to 3.5%.

"If it comes in hotter than expected, it almost locks a rate hike in" for June, said Heppenstall.

Gas prices are down from last Memorial Day weekend

American traveling this Memorial Day weekend will spend $1.6 billion less on gas compared to a year ago, reports my colleague Matt Egan.

The national average for regular gasoline was at $3.57 a gallon as of Friday, AAA data shows. That's down by more than $1 from the same Friday one year ago prior to the holiday weekend, when sky-high oil prices due to Russia's invasion of Ukraine sent prices at the pump surging.

Drivers in all 50 states can expect cheaper gas prices this holiday weekend.

"Those who waited to take a road trip this summer are being rewarded with big savings on gasoline," said Patrick De Haan, head of petroleum analysis at GasBuddy.

He sees about a one in three chance that the national average for regular gas will hit $4 a gallon this summer, down from a 2 in 3 chance in January.

But there are some risks that threaten De Haan's outlook.