What are the odds the Fed hikes rates rather than cuts?

US Treasury Yields (^TNX,^TYX,^FVX) are moving higher as the debate over when the Federal Reserve will cut interest rates continues to heat up amid current market conditions. The US economy shows strength as consumers continue to spend despite inflation, according to March's retail sales data, which could encourage Fed officials to hold off on rate cuts.

Richard Bernstein Advisors Director of Fixed Income Michael Contopoulos joins Yahoo Finance to break down the recent movements in the bond market and the potential for the Federal Reserve to push rate cuts further down the line in 2024, much to the dismay of many Wall Street forecasts.

Contopoulos elaborates on the probability of an interest rate hike: "I put the odds as not so much that I think they will hike, as much as I think that the market will start to price in some probability of a hike. Which is meaningful from a market perspective, both from a credit perspective as well as from an equity perspective. Whether or not they actually get to that point is a different story."

For more expert insight and the latest market action, click here to watch this full episode of Yahoo Finance.

This post was written by Nicholas Jacobino

Video transcript

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- The bond sell off intensifying, and today's action taking a look at yields shooting to the upside. You've got the 10-year right around 4.65. You've actually got the 2-year just shy of that 5% level. Now, the move higher in yields coming as investors continued to push out their bets on rate cut timing, expecting maybe we're not going to see the Fed cut clearly as early as June. Now, there's talk about might not even see a rate cut before the end of the year.

Here to break it all down is Michael Contopoulos. He is Director of Fixed Income at Richard Bernstein Advisors. Michael, it's great to have you here. So talk to us just about your reaction in the spike higher that we've seen in yields with the 2-year just below that 5% level.

MICHAEL CONTOPOULOS: Yeah. You know, this isn't really surprising to us. When we came into 2024, one of the big themes at RBA was that we were going to see higher rates rather than lower rates. That the market was, quite frankly, being absolutely ridiculous in pricing in six cuts for the year.

We couldn't believe that back then they were pricing in a cut for March. I mean, growth is quite strong in the US. When you look at most of the economic indicators out there, they bottomed roughly a year ago, whether that be leading economic indicators, PMIs, durable goods orders, industrial production, you look at market-based measures like credit spreads, copper. You know, they're all sort of breaking out, or in the case of spreads, breaking lower.

You look at lending standards, they've loosened. I mean, there's really zero reason for the Fed to hike from a growth-- or excuse me. Cut from a growth perspective and then you throw on inflation. And it's a whole other ball of wax. And there's just really, in our view, very little chance that they're going to be cutting any time soon. And the market will probably have to price in a hike at some point again.

- When would you anticipate that, Michael?

MICHAEL CONTOPOULOS: Well, I think it's going to take a little bit of time before investors fully recognize that eventuality. My guess is once you get past June or July and you start overlapping the lows in inflation, which really weren't a year over year basis in June of last year, I think you're going to see the market start to say, wow. Inflation is not slayed. We're not going back down to 2%. Economic growth is actually accelerating. Housing prices are going up, which have a direct effect on owners equivalent rent, OER.

OER is about a third of CPI. And that was supposed to be the driver to bring us lower inflation and more towards the 2% mandate this year. And in fact, what it's going to end up being is it's going to be a headwind to inflation. As home prices are actually going back up, OER is also going up. And so I think you're going to really start to feel that pretty much from now through the summer.

And again, as you start to overlap the lows on a year over year basis come June and July, you know, you could easily see 3 and 1/2% or high 3% inflation. Again, we're not talking 5%, 6%, or 7% inflation. But you could be talking mid 3's. And that's nowhere close to 2. And I think at that point, investors are going to have to start thinking about tighter policy rather than easier policy.

- Michael, talk to me just about the odds of this happening. When you weigh the next move here from the Fed potentially being a rate hike, how much more likely do you see that rather than the next move being a rate cut?

MICHAEL CONTOPOULOS: Well, I put the odds as not so much that I think they will hike as much as I think that the market will start to price in some probability of a hike, which is meaningful from a market perspective, both from a credit perspective, as well as from an equity perspective. Whether or not they actually get to that point is a different story. But I do think, and you already saw it last week, or two weeks ago, several Fed officials out there talking about no cut in 2024.

And that if the data continues to show an increase in inflation, that they may have to start thinking about tightening policy again. So sometimes, just the act of talking about it can do the Fed's work for themselves. So maybe it's a 20% chance it's a hike, maybe it's a 50% chance of a hike. I don't know if that's necessarily the right question to be asking because the process of getting to the point where it's even considered is what's important and what will start to move markets.