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London - The Federal Reserve is increasingly at odds with traders. Even after the second consecutive month of US employment reports came in lower than economist forecasts, some Fed officials reiterated that interest rates may rise this year.
The market response: There’s only a 37% probability of that occurring. Two months ago, the odds were 77 percent, according to futures data compiled by Bloomberg.
With this pullback, traders also reduced the pace at which they think the Fed will raise. By the December 2016 meeting, a 65% chance of two or more rate increases of 0.25 percentage point have been priced in; at the start of this year futures suggested such an outcome was a near certainty.
“There is a massive discrepancy between what the market is pricing and the Fed’s forecasts,” said Alexander Aldinger, a senior government-bond analyst at Bayerische Landesbank in Munich. “We think the market is currently too pessimistic.
We only look for a soft path in the US, which should not derail a rate hike in December. It is more likely that the Fed will hike once this year and then allow for a longer pause until the end of the first half of 2016.”
Since officials of the US central bank held off raising rates in September, citing international risks to the economy and global market turmoil, traders pulled back their expectations for when the Fed will move as US growth also seemed to be losing momentum.
Peter Fisher, senior director of the BlackRock Investment Institute, said last week that the last jobs data had reinforced a question in his mind - whether the Fed had missed its window?
Nonetheless, San Francisco Fed President John Williams said Tuesday that “it still makes sense to raise rates this year.” He acknowledged that the markets aren’t completely on board with the Fed on timing of liftoff but “we have to make the right decision no matter what.”
Further ahead, the majority of Fed policy makers suggested in September that their targeted Fed funds rate will be above 0.75% by the end of 2016, according to the “dot plot” - a set of projections from members of the Federal Open Market Committee that include forecasts of where each official thinks the Fed should have it’s benchmark rate at any given time. Futures indicate there is only a 35% probability of such an outcome.
At start of year, those odds were about 97%.
This dot plot from the September 17 meeting continued the trend of the previous two quarterly forecasts moving lower, suggesting policy makers were moving closer to market-based measures that indicate a more gradual ascent and lower ending point on the path to higher rates.
