By Gertrude Chavez-Dreyfuss

NEW YORK, (Reuters) – Eurodollar futures that reflect U.S. interest rate outlooks over the next few decades have begun to value in an incremental easing by the Federal Reserve of monetary policy in 2024. It would only be two years from the expected Fed tightening in March 2024, if that happens.

It is expected that the U.S. central banks will raise its policy rate by 25% at their March meeting. Currently, it stands at zero. Over the past few sessions, money market odds of a 50-basis point hike have fallen from as high at 80% on Friday to as low as 37% today.

The implied yield for December 2023 eurodollar contracts was 2.235% according to market pricing. This is a proxy rate for federal funds rate which banks and other lenders charge for overnight loans that are required by U.S. central banking.

Analysts believe that this is the tipping point of the Fed rate-hike cycles, the “terminal rate”, with implied yields falling to 2.188% in March 2024, 2.125% June, 2.095% September and 2.085% December.

Officials at the Fed estimate that 2.5% is the long-term neutral interest rate. This is not constricting or stimulating economic growth.

Jim Caron is portfolio manager and global macro strategist for the global fixed-income team. He stated, “If you take the (yield curve) out at ’23-24 it flattens out and inverts, which would argue to price in rate cuts.” Morgan Stanley Investment Management.

You basically get the same message from the long end. This tells you, “The more they raise growth and the slower they slow it down, the more that they steal from the future and so long-term growth prospects don’t look very bright.”

Analysts said that the expected rise in interest rates over the next two-years of approximately 220 basis points suggests a quicker pace of Fed tightening. This could include one to two percentage point increases.

Fixed income strategist Dan Belton from BMO Capital, Chicago pointed out that the start of the month saw “futures market prices for a later peak in the Fed’s hike cycle, closer towards 2028 or 2029.”

He said that market participants were also looking for Fed hikes on a much shorter path, and the peak rate closer to 1.82% than it is right now.

EURODOLLAR CURVE Inversion

The curve inverted due to the lower implied yield in the Eurodollar Futures 2024 contracts than in 2023. This is usually a bad sign.

Yield curves generally slope up with closer maturities yielding more than later dates. Because of the greater likelihood of default or inflation, longer-term debt is more risky and will yield a lower return.

On Friday, for example, the spread between December 2023 and June 2025 contracts collapsed to a mere -14 basis point. An year ago this curve was more steep and there was a spread of 74 basis points.

According to Brian Reynolds (chief market strategist, Reynolds Strategy) and former portfolio manager in money markets for an investment firm, “It’s like traders in the Eurodollar Futures Market think the Fed will overdo it next Year and then need to reverse course and drive rates back down.”

In recent times, the curve of eurodollars has been inverted at least once.

The inversion in June 2018 suggested that the Fed should cut interest rates when it was tightening. After hiking interest rates in December 2018, Fed policymakers reversed their course and cut the rate in July 2018.

The benchmark overnight rate for lending was cut by the central bank in 2020 to close to zero because of the global coronavirus pandemic.