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Could the Fed hike rates? Bond traders need to at least think about it: strategist


Only a month ago, parts of Wall Street were considering what was being described as an “unthinkable” scenario of no interest-rate cuts by the Federal Reserve this year. Now, a strategist at one big bank is going a step further in the higher-for-longer theme on rates.

Related: Does January jobs report put interest-rate hike on the table? Probably not — but watch this space, says economist

Jason Williams, a global market strategist at Citigroup, sees the need for markets to factor in a possibility of future rate hikes by the central bank. Interestingly, his view, in a note dated Feb. 9, comes ahead of Tuesday’s consumer-price index for January, which is expected to show the annual headline inflation rate falling below 3% for the first time in almost three years.

Read: Financial markets are counting on consumer-price inflation to fall below 3% for first time since 2021

The view from Citigroup suggests that a more complex and nuanced scenario may unfold this year than the one currently held by many investors, in which declining inflation should automatically equal Fed rate cuts at some point this year. At the core of Williams’ thinking is the possibility that a debate could heat up again over the appropriate level of the neutral rate of interest that neither stimulates nor restricts the economy.

One of the biggest puzzles of the recent rate-hiking cycle is why higher interest rates haven’t had more of a damping effect on the economy, considering the Fed has pushed borrowing costs up by more than five full percentage points since March 2022. On Monday, Alan Ruskin, a macro strategist at Deutsche Bank, said that one crucial reason is that households were able to refinance at low rates before the Fed began hiking.

At Citigroup, Williams said that “the market should price in some risk of future hikes — look to 1998.” That’s when the Fed undertook a short-lived easing cycle which then led to rate hikes the following year. If inflation does not return to a consistent 2%, “the upside tails around future Fed hikes should increase” from a “very depressed level,” he said.

Financial markets finished Monday’s trading session in wait-and-see mode ahead of January’s CPI report on Tuesday. Treasury yields finished little changed, while stocks
DJIA

SPX

COMP
closed mostly lower.

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