Federal Reserve rate hike expectations dialed back

As recently as last week, markets were getting set for the return of large Fed interest rate rises. However, concerns about the banking sector have triggered a sharp decline US bond yields as investors questioned if the Federal Reserve and other central banks can keep hiking interest rates to curb inflation.

Two-year Treasury notes, which move in step with interest rate expectations, have tumbled 98 basis points in the last five days, the biggest drop since the week of Black Monday on Oct. 19, 1987. On Wednesday, they have fallen from 4.413% to pay as low as 3.72%. Markets are now pricing in an 80% chance of a 25 basis point Federal Reserve hike next week and are pricing in a 50% chance of no change. Moreover, the December Fed funds futures, which reflect the overnight rate that banks use to lend to each other has dropped to 3.62% in a sign market expect the Federal Reserve to be cutting interest rates by year's end, if not before.