Wednesday, November 21, 2012

Shifting expectations of the Fed's first rate hike

Discussions on the first tightening move by the Fed are taking place once again, as investors become a bit more optimistic about the US economy. The tightening action timing was brought into spotlight by the latest speech by Bernanke. The Chairman did not discuss further QE in 2013, which was somewhat unexpected (and disappointing to some).
WSJ: - Interest-rate futures nudged forward monetary tightening expectations Tuesday after remarks from the head of the Federal Reserve didn't offer hints of more Treasurys buying next year.

With a current Treasury buying and selling program due to end this year, bond investors have increasingly expected the Fed to announce it will continue the purchasing-end of those efforts in 2013. Though he maintained that the labor market is still far from healthy, Fed Chairman Ben Bernanke didn't tip his hand on future stimulus measures in a speech Tuesday, causing some disappointment.

The thinly traded July 2015 Fed Funds futures contract reflected a 50% chance for a 0.25 percentage point policy-rate increase at the mid-2015 Fed meeting. That's up from 44% late Monday. As the Fed has stated, it doesn't intend to lift its policy rate from near-zero through at least mid-2015.

Odds for an early-2015 rate move rose to 12% from 8%.
The October survey of primary dealers was showing 41% of Wall Street economists expecting action by mid 2015.  Rate futures are now pointing to a 50% probability.

Question for primary dealers: "Of the possible outcomes below, please indicate the percent chance you attach to the timing of the first federal funds target rate increase." (source NY Fed)

In fact the Fed Funds futures two years out (October 2015) are implying 50bp for the overnight rate.

Fed funds futures implied overnight rate (source: CME)

It is not surprising that market participants are beginning to talk about the end of zero rate policy from the Fed. The spike in housing construction has been quite sharp (see earlier forecasts) and some are beginning to think this could lead to a more robust growth going forward.
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