Markets place limited bet on Fed rate rise

Posted on September 20, 2016

The Marriner S. Eccles Federal Reserve building stands in Washington, D.C., U.S., on Tuesday, Sept. 1, 2015. Bill Gross said the Federal Reserve has waited so long to raise interest rates that any move now may be labeled "too little too late" as market turmoil restricts the room for policy makers to act. Photographer: Andrew Harrer/Bloomberg©Bloomberg

Financial markets are putting only modest odds on an increase in short-term rates at the US Federal Reserve’s meeting on Wednesday. Nevertheless, the gathering promises to be an important one.

A number of policymakers have been calling for an upward move in rates in recent weeks and some will press their case this week. If the Federal Open Market Committee decides to keep policy unchanged at 2pm on Wednesday it may well signal that an increase is expected by the end of the year.

    In addition, the central bank may further reduce its estimate for where the federal funds rate will end up at the end of the rate-lifting cycle, reflecting a more downbeat assessment of the economy’s longer-term outlook.

    Why is a rate increase not widely expected?

    Janet Yellen, the Fed chair, said in late August that the case for a move was strengthening and that the Fed was on track to meet its objectives of full employment and price stability, words that would seem to suggest an increase was not far off.

    A vocal contingent of Fed voters has been making the case for higher rates, among them Loretta Mester of the Cleveland Fed, Esther George of Kansas City and Eric Rosengren of the Boston Fed. Dennis Lockhart, the Atlanta Fed chief, has said there should be a serious discussion about the possibility of an increase this week.

    The Fed’s policymaking body is divided, however. Two members of the Fed’s board of governors — Lael Brainard and Daniel Tarullo — have signalled this month they are in no hurry to lift rates. Another board member, Jerome Powell, said in August he is patient given below-target inflation.

    Recent economic data have been on the soft side — most importantly the September jobs report, where payrolls were shy of expectations. Against that, consumer price inflation numbers firmed last week.

    Fed plays poker with tempestuous markets

    Traders work on the floor of the New York Stock Exchange (NYSE) in New York, U.S., on Friday, Sept. 16, 2016. U.S. stocks slipped to trim a weekly gain as investors awaited next week's Federal Reserve meeting, with economic indicators pointing to uneven growth in the world's largest economy. Photographer: Michael Nagle/Bloomberg

    No change is expected but there are some reasons to raise rate

    The result is that market odds on a move are fairly low at 18 per cent. The Fed does not like to surprise the markets when it raises rates — and some investors think the central bank will be particularly wary of springing a market-jolting surprise on traders less than two months from a hugely consequential presidential election.

    Analysts at Goldman Sachs have said that apart from two increases in 1994, the market-implied odds of a move have been at least 70 per cent before each Fed rate rise.

    Does that mean no Fed action at all in 2016?

    No, a move is still on the cards for 2016. If the Fed holds fire on Wednesday it could well start laying the groundwork for an increase in December. A compromise between the hawks and doves on the FOMC could include a signal that the bar to an increase before the end of 2016 is relatively low.

    The Fed has two meetings left this year — on November 1-2 and on December 13-14. It is highly unlikely to move in the November meeting: it does not issue forecasts or hold a scheduled press conference that month, and the meeting is being held only days before the election.

    That leaves December. If the Fed pulls the trigger then, it would mean only one rate increase compared with the four that policymakers predicted in December last year, underlining just how drawn-out this rate-lifting cycle is proving to be.

    Markets too dependent on central banks

    A national flag of Switzerland flies outside the headquarters of the Bank for International Settlements (BIS) in Basel, Switzerland, on Tuesday, June 25, 2013. Mark Carney, chairman of the Financial Stability Board (FSB) and the next Bank of England governor, said global regulators will set up a task force with banks in a bid to repair or replace tarnished benchmarks in the wake of Libor and other rate-rigging scandals. Photographer: Gianluca Colla/Bloomberg

    More balanced policy mix needed to safeguard global economy, says BIS

    One key area to watch in the Fed’s post-meeting statement this week is whether it offers a description of the balance of risks on the horizon. If it described risks as being “nearly balanced” it would be a cue to the markets that a rate move is increasingly possible in the coming months.

    Some policymakers, including Mr Rosengren of Boston and John Williams of the San Francisco Fed, have been getting more concerned about the financial stability risks of leaving rates too low for too long, and analysts will be looking for hints of the prevalence of this view when Ms Yellen speaks after the meeting.

    What about the Fed forecasts?

    Close attention will be paid to the so-called dot plot, which sets out policymakers’ expectations for rates in the coming years. In June, when the last forecasts were released, the median prediction was for two rate increases in 2016.

    That may come down to one. In June no officials were predicting zero rate rises in 2016. Markets will be watching to see if there are now any officials who are seeking to keep policy unchanged all this year.

    There is a good chance that the dot forecasts for the coming years could also be reduced. This would be consistent with policymakers’ sense that the so-called neutral rate — the rate consistent with a stable economy — will stay lower for longer than analysts expected, which limits the Fed’s scope to tighten policy.

    Roberto Perli of Cornerstone Macro expects the new forecasts to show two or three quarter-point increases a year. Analysts will also be watching the Fed’s forecast for the longer-run federal funds rate, which currently stands at 3 per cent, to see if this is also reduced given the sluggish outlook.

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