While US Federal Reserve members continue to do their utmost to prepare markets for a potential rate hike, it’s clear that investors aren’t buying their rhetoric at present. As the chart from ANZ shows below, markets do not believe the Fed will hike this year, and they’re not expecting a rate increase to occur until the second half of 2016.
For clarity, the red dots are the median FOMC member forecast – those who set interest rates in the US – for the outlook for the Fed funds rate (FFR). The blue line is market pricing for the expected level of the FFR before the FOMC last met in late September, while the orange line is market pricing as of October 15.
The federal funds rate is one of the most influential interest rates in the US economy, and, for those in Australia, is akin to the RBA’s cash rate.
Clearly, while FOMC members continue to suggest interest rates will most likely move higher this year, the markets think that’s now highly unlikely.
“As Q4 2015 gets underway, the market is unconvinced that the FOMC will raise interest rates this quarter attaching a 30% probability to a move in December,” wrote ANZ.
“The low probability reflects scepticism about the Fed’s current forward guidance.”
Having delayed earlier in the year, displaying caution that perhaps was not warranted, the FOMC keep finding reasons to push back monetary policy tightening. Initially it was awaiting further improvement in the labour market, then it was confidence that inflation would likely move back towards the committee’s 2% inflation target. Then, most recently, it was market turmoil and concern surrounding emerging markets, particularly in China.
Notice a pattern? The markets certainly do, and are sceptical the pattern seen earlier in the year will dissipate in the months ahead.
Recent US labour market indicators have underperformed, bringing into question whether tightening in the labour market will stir wages pressure and, as a result, inflation. It’s an uncertain environment to be considering raising rates, even excluding the concerns surrounding emerging markets that saw the FOMC hold off raising rates in September, which are still apparent today.
Clearly the FOMC’s forward guidance has been lost on the markets – they simply don’t believe them. Either the FOMC will be forced to make another embarrassing policy backflip or shock the markets by hiking rates either later this month or in December.
All things considered, neither seems palatable at present.