Is The Fed At Risk Of Choking The Market?
Everybody was looking forward to hear what Janet Yellen had to say last week, as people were waiting for a cue about what the Federal Reserve might do next month and later this year. Will the Fed keep the interest rates stable? Or will we indeed see three additional rate hikes to push the benchmark interest rate towards 1.25%?
It’s not a secret the Federal Reserve has been slowly walking back on its previous promises as just five months ago, the institution said it would very likely implement no less than four rate hikes in 2016. We’re now nearing the end of May and not a single rate hike has occurred yet, and the chances of indeed seeing four, or even three rate hikes are now pretty much zero.
In fact, Yellen didn’t really bring any new data or details to light, although she now did go on record stating that a rate hike in June might be likely, but that the Fed would have to be very careful to make sure it’s not ‘choking’ the market. Yellen not hinted at the fact the interest rates would be gradually increased ‘at an appropriate time’, but warns for the impact of increasing the interest rates too fast and too high.
You might want to read between the lines here, and we are interpreting this as seeing a rate hike in June and perhaps one in September or October, but we are pretty certain there won’t be no third rate hike. And we’re not alone. If you’d have a look at the market data from the 30 Day Federal Funds futures, the market clearly doesn’t believe in aggressive rate hikes and still expects a very moderate increase in the interest rates. Just have a look at the futures for September and December:
Source: CME Group
Just to give you a better impression of what this means, the market is now expecting just a 28% chance to see a rate hike in June, but a 68% to see a rate hike by September. As you can see on the next image, the current price levels of the Fed Funds futures are indicating there’s a 32% chance nothing will happen, and a 46% chance the benchmark interest rate will be increased by one step.
Source: CME Group FedWatch
More importantly this also indicated there’s just a 21% chance there will be a two-step rate hike and a very tiny 2.3% chance the Federal Reserve will boost the benchmark interest rate all the way up to 1.25%.
Sounds reasonable, no? But what we cared about the most were the longer-term expectations of the market. The expectations for February next year aren’t very different from September as the market is still just incorporating an 83% chance there will be a rate hike (which is just 15% more than in September), but what’s even more important is that the odds are in …read more
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