THE MARKET DOES NOT BELIEVE THE FED’S INTEREST RATE FORECAST…

By Walter Kurtz, Sober Look

Misconceptions still persist that the Fed is on hold with respect to rates until at least late 2014.

WSJ (Feb 16th): … They said after their last meeting in January they expect to keep rates at“exceptionally” low levels until late 2014.

The markets would disagree. The Fed Funds futures have the first rate hike (25bp) centered around August of next year and the second hike (to 50bp) on July of 2014.

Fed Funds Futures (implied rate) expected rate hike dates

The market has completely reversed the Fed’s announcement on January 25th. In fact the expectations for the first hike are now even earlier than they were before the Fed’s statement.

Fed Funds Futures (implied rate) expectations of rate hike shifted to an earlier date than was priced in before the Fed’s announcement

 

The market is fully ignoring the FOMC’s prolonged zero rate forecast. If Bernanke tried to lower short-term rate expectations by the announcement, he failed miserably (though it’s possible that was not his intent), as the rate expectations are now even higher than prior to the announcement. Why is the market pricing in higher short-term rates (an early rate hike)? The answer has to do with relatively strong economic data coming out of the US and rising commodity prices. All of this is driving up inflation expectations. The chart below shows TIPS implied 2-year forward inflation expectation now comfortably above 2%, the Fed’s inflation target.

TIPS implied 2-year forward (breakeven) inflation expectation

 

The market is prepared for the first rate hike in about 16 months, possibly sooner. Those who are becoming complacent believing the Fed is on hold for the next 3 years will be in for a rude awakening.

Sober Look

Sober Look

Sober Look was founded by Walter Kurtz, a New York based hedge fund manager and credit markets specialist.

More Posts - Website

  • VII

    If a “recovery” can’t with stand a 25 bp hike from 0 maybe we shouldn’t call it a recovery.

    “rude awakening” with a 25 bps monetary tightening? Where I come from that’s still as loose as down town Becky Brown.

  • Octavio Richetta
  • Old Dog

    “The markets would disagree. The Fed Funds futures have the first rate hike (25bp) centered around August of next year and the second hike (to 50bp) on July of 2014.”

    And we ALL know the markets NEVER get it wrong.

  • Andrew P

    Maybe Bernanke is watching the same indicators as ECRI is, and expects a recession. In that case, the current boom is pure Central Bank juice created, you know, for this years elections in the US and France.

  • SC

    Normally you would be right ,but this is normal is it? At extremes small nomianl changes make for large % consequences. I recall saying much the same to someone who said when would you buy a property.My answer when rates are very high on the basis that 1 or 2% change on 15% is peanuts,but the same change on 1 or 2% is huge. You see the former makes it rpbable that affordability and changes to same are likely to be favourable ,but the latter …painful. If only people would simply appreciate the idea and virtue of locking borrowing to term required instead of this nonsensical variability that has bcome the norm these days.Variability at historical lows is not something I want to contemplate.

  • quark

    The market is wrong.

  • alex parkhurst

    Go back 1 year, 2 years and 3 years and you will see the same predictions. They were wrong then.

  • wh10

    How often does the Fed announce something like this but they go on to change their position when the time rolls around?

  • Detroit Dan

    Another symbol of the Fed’s impotence. Conventional wisdom is that the Fed is the Wizard of Oz and has superhuman powers, and that the Fed can fix the economy just by changing expectations. In reality, the markets have learned that none of that is true. For the most part, the Fed follows inflation trends.

    Having said all that, I have to agree with alex parkhurst in noting that the fed funds futures market has been continually wrong for the last several years…