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Market Extra: How a hot U.S. jobs report moved the goalposts on interest-rate expectations

Traders and investors are putting the prospect of the highest U.S. interest rates since 2006–07 back on the map, following a blockbuster January jobs report.

Data released on Friday showed the U.S. created 517,000 new jobs last month, far more than the 187,000 expected by economists — placing a 5%-plus federal funds rate within sight in a matter of months. The report “has all but locked in another rate increase” and has moved the goalposts on the terminal rate or level at which the Federal Reserve will end its rate hikes, said BMO Capital Markets strategists Ian Lyngen and Ben Jeffery.

Traders reacted on Monday by boosting the chances of a fed-funds rate between 5% and 5.25% by May, to 70% versus 60% on Friday, and sending rates on 6-month

and 1-year Treasury bills

inching closer to 5%. Treasury yields rose across the board as all three major U.S. stock indexes


dropped in late-morning trading.

The fed-funds rate currently sits in a range between 4.5% and 4.75% following a quarter-of-a-percentage-point hike last Wednesday, and is up from almost zero at this same time a year ago as policy makers turned their attention to fighting inflation. The Fed hasn’t lifted its benchmark rate target to 5% or higher since May-June of 2006; it didn’t cut rates until September 2007.

“We were all thinking that the Fed’s heavy lifting was done and that there was light at the end of the tunnel,” Derek Tang, an economist at Monetary Policy Analytics in Washington, said via phone. “What if it isn’t a light, but an ongoing train of higher inflation and demand? January’s job report tells us that the labor market is even stronger than we thought and we could get more inflation if the Fed doesn’t do something about it.”

In December, via their economic projections, policy makers flicked at the likelihood of a 5.1% terminal fed-funds rate forecast in 2023. Investors and traders largely brushed aside the outlook, however, because they were counting on officials to lose their nerve as the risks of a U.S. recession seemed to grow. Signs of slowing inflation in January’s data releases for December only added to the idea that the Fed could end its rate-hike cycle soon.

Now, financial markets are factoring in an almost 97% chance of another quarter-point hike in March, a 70% likelihood of another in May, and growing odds of a third rate increase of the same size in June, according to the CME FedWatch Tool.

January’s job gains were accompanied by a drop in the unemployment rate, which fell to a 54-year low of 3.4%, despite the Fed’s string of eight straight rate hikes since March 2022. Four of those hikes were by a jumbo three-quarters of a percentage point.

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