The possibility of the Federal Reserve raising interest rates within a year has increased to 20%! Investors are no longer "stubborn"

US Treasury yields surge, S&P 500 falls for six consecutive days, will the Fed raise interest rates again this year?

According to media reports on Tuesday, as US economic data continues to be strong and Fed officials make hawkish comments, investors are starting to bet that the Fed may raise interest rates again, a prospect that was once considered unimaginable.

Analysts point out that investors' expectations for another Fed rate hike continue to rise. The options market currently shows a probability of around 20% for a rate hike in the US in the next 12 months, a significant increase from the beginning of the year.

Ed Al-Hussainy, a rate strategist at Columbia Threadneedle, pointed out that option pricing reflects a probability of around 20% for a rate hike this year. Benson Durham, Global Policy and Asset Allocation Director at Piper Sandler, analyzed that the probability of a rate hike in the next 12 months is close to 25%, while analysis of Barclays Bank's option data shows this probability to be 29%.

This shift in expectations has had an impact on the bond market, with the yield on the two-year US Treasury, sensitive to interest rates, briefly rising to 5.01%, reaching its highest level in 5 months, while US stocks experienced their longest consecutive decline in 18 months before a sharp rise on Monday.

Next move: rate cut or rate hike?

With US inflation exceeding expectations for three consecutive months, options market investors are beginning to seriously consider the possibility of a Fed rate hike. Former US Treasury Secretary Summers stated that the latest data showing sustained inflation pressure suggests that the Fed's next policy action may be a rate hike rather than a rate cut. Summers believes that the probability of the Fed raising rates in the next step is as high as 15%.

Richard Clarida, economic advisor at Pimco and former Vice Chairman of the Fed, pointed out:

If the data continues to disappoint, I believe the Fed will have to reconsider raising rates. Although a rate hike is not his base case, once the core inflation rate rises above 3%, the likelihood of a rate hike will increase.

Currently, the market generally expects the Fed's preferred inflation gauge - the March core PCE index - to reach 2.7%. In response, Greg Peters, Co-Chief Investment Officer at PGIM, stated:

Considering a rate hike is completely reasonable, I feel more optimistic about the market's pricing compared to the beginning of the year, when a rate cut was only expected in extreme circumstances.

New York Fed President Williams previously stated that the current economic conditions do not warrant a rate cut. He also added, "If the data shows that we need higher rates to achieve our goals, then we will obviously consider this step."

Furthermore, despite the market using options to hedge against rate hike risks or profit from them, there is still a possibility of a rapid rate cut. A rate cut remains the base case scenario, with futures market pricing indicating traders expect one to two 25 basis point rate cuts this year, lower than the six to seven expected in January.