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This year there have been significant moves around in interest rate expectations in the US. As the chart below shows, in January, the market expected the Federal Reserve to cut interest rate by 0.25% seven times (1.75% in total) by the end of this year. As inflation data deteriorated, there was a sharp drop in the number of cuts expected. By May the market was expecting one cut of 0.25%. This big change in interest rate expectations was a major reason behind the dull performance by the bond markets in the first half of the year.
Since June, better inflation reports from the US has led to another marked change in interest rate expectations. We have moved since June from expecting one cut in US interest rates by the end of the year to two, and perhaps three. We thought expectations were too optimistic in January and thus we were not surprised to see the line in this chart fall. We believe they are now fair, with an equal chance of going up or down which should deliver a better interest rate environment for bond markets in the second half of the year.
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