While the pausing of the Federal Reserve’s rate-hiking programme earlier this year gave hope to markets of further easing, expectations of an imminent rate cut could be wide of the mark, according to market experts.
The US central bank’s rate-hiking programme last year – which aimed to ‘normalise’ interest rates after years of loose policy – contributed to a difficult 2018 for markets, in which the S&P 500 recorded its first annual loss since the global financial crisis.
However, the decision to halt the programme earlier this year amid weaker economic data sparked a rally in markets and made the prospect of rate cuts to support the economy more likely.
While the re-opening of the US-China trade issue stymied that progress, more positive noises from the Fed have sparked a further rally in recent days.
However, investors may have gotten ahead of themselves, according to George Lagarias (pictured), chief economist at Mazars. 
“Following remarks from [Fed chair] Jay Powell in early June that the Fed would support growth, and given evidence of slowing economic activity in the US, investors assumed that the Fed would completely reverse its previously hawkish strategy and start cutting rates,” he explained. “And, as always, when the Fed is dovish, traders are happy to buy opportunities at market dips. Therein lies the risk.”
He said markets now expect three rate cuts until the end of the year, meaning cuts in all meetings after September, although that is unlikely.
“While the bond futures markets, from where those odds are derived, are hardly representative of the whole market, it is still indicative that maybe investor expectations have overshot reality,” he said.
For three rates cut to happen until December, he argued, the economy would have to be in freefall.
“Currently this is not the case,” he said.
Indeed, Lagarias doesn’t see signs of recession that would justify a triple rate cut for the rest of this year.
“Manufacturing has somewhat slowed down, but employment is still very high, wage growth decent, consumption is hanging on, consumers and businesses are optimistic, and the Fed is now projecting a 2 per cent annualised growth rate for Q2, 0.5 per cent higher than two weeks ago,” he explained.
He advised caution in the weeks to come, given “the possibility of even the slightest word [of the Fed] being misinterpreted”.
Indeed, Lagarias said chair Jerome Powell will have to balance a more dovish message with bringing rate expectations back to reality, without hurting growth or market exuberance at the next meeting of the Federal Open Market Committee (FOMC) on 19 June
Sandra Holdsworth, head of rates at Kames Capital, said markets are likely to keep speculating for a bit longer about the Fed’s stance on rates although there is little need for rates to be either higher or lower than at present.
She said that data showed that while the US economy was expanding at a slower pace than 2018 it is performing better than the Fed had forecasted for this year.
“The infamous ‘dot’ plot which shows how the committee members see interest rates evolving over the next few years will, in all likelihood, continue to show an upward path in rates into 2020, completely at odds with market pricing,” Holdsworth said.
Federal Open Market Committee ‘dot plot’
Source: Federal Reserve
“Expectations are building in the bond markets that the US Federal Reserve is about to embark on an easing cycle starting in July, and market pricing suggests that rates will be 0.75 per cent lower by year-end from current levels,” Holdsworth noted.
“The validity of the dot plot has to be questioned in an easing cycle as the FOMC does not pre-plan rate cuts, they usually are reactive to events, crises or recession.”
She added: “The FOMC also forecasts a long run rate, which is currently at 2.75 per cent, and again looks vastly different from bond market pricing.”
Kames Capital’s Holdsworth said that rates are expected to be around 2.15 per cent in 10, 20 and 30 years’ time, which illustrate how far the bond market has ‘front run’ Fed policy expectations.
As such, Holdsworth (pictured) considered the implications of a potential move towards easier monetary policy for markets. 
“Firstly, and probably most importantly, by signalling it will ease, the implication would be that we have seen the top of the interest rate cycle,” she said. “That should surely mean the long-term rate must be lowered substantially, closer perhaps to the average rate of the last 10 years which is a mere 0.5 per cent.”
She explained: “This is a bit extreme as it does include the immediate post-crisis period, but even over the last five years it is still less than 1 per cent.”
However, such a move would put the rate over 100 basis points lower than that implied by the market and 175 basis points from the FOMC estimate.
The Kames head of rates said it would be “simply too big a statement to make at this current juncture when US economy is performing well, employment is still rising and financial conditions are easing”.
“Should they do so, however, yields across the whole of the fixed income universe have a long way to fall,” she said.
“A change in stance like this may well also be positive for riskier assets as the move is perceived as less of a response to concerns but more a ‘recalibration’ of Fed thinking about what the ‘neutral’ rate for the economy is,” she added.
“On an international comparison, US interest rates are far higher than in Europe and Japan as president Donald Trump is so fond of pointing out.”
Holdsworth concluded: “The FOMC have surprised us a couple of times this year. We should remain alert to more surprises, they could be even more meaningful than what we have seen already.”