lunes, 31 de agosto de 2015

lunes, agosto 31, 2015

The Fed’s Longer Run Rate Projections Look Increasingly Untenable

By Jon Hilsenrath


Investors seem to have an endless fascination with the question of whether the Federal Reserve is going to raise short-term interest rates in September. The probability of a move has clearly gone down of late. Minutes of their last policy meeting showed officials were already divided about the prospect of raising rates in late July, and since then financial market conditions have made it even more difficult to act: Falling oil prices weigh on inflation and prevent the Fed from approaching its 2% inflation target. The rising dollar weighs on growth and inflation. Falling stock prices undermine confidence in the economy.

Perhaps more interesting than the timing of the first rate hike is what the market is signaling about the outlook for short-term interest rates into 2016 and beyond. Fed funds futures contracts for October, November and December 2016 are priced for an average benchmark fed funds rate of 0.74% at the end of next year. For the fourth quarter of 2017 they are priced for an average benchmark rate of 1.29%.

These rates have come down substantially since Fed officials last made public rate projections in June. Even then the Fed was above the market. Now it is substantially above the market.

The median forecast among Fed officials for the fourth quarter of 2016 had the fed funds rate at 1.625%, nearly a percentage point above current market expectations. The median forecast for the fourth quarter of 2017 is 2.875%, more than a percentage point above current market expectations. Even the most dovish Fed official, with a fed funds rate projection of 2% in the fourth quarter of 2017, is well above futures market pricing of 1.29% for that period. (The Fed doesn’t identify which individuals make which forecasts in its ‘dot plot.’)

There are technical reasons why market prices would run below Fed projections. The market is pricing all possible risks on the horizon, including the risk of a return to recession or a wave of global deflation. Fed officials worry about these outcomes, but they are only putting down their one best guess of the most likely outcome in official forecasts. The distinction can lead to market estimates that undershoot official estimates.

Still, Fed forecasts for the path of rates over the next three years look increasingly untenable in an era of persistently low growth and inflation. Other market indicators tell the same story. A two-year Treasury note maturing in August 2017 yields just 0.568%. That is inconsistent with rates of 2.875% in two years. Eurodollar futures contracts, which measure expected 3-month interbank borrowing rates in the future, are priced for a 1.69% interest rate at the end of 2017, also well below the Fed’s projections.

What will happen at the September policy meeting? Put aside for a moment the question of whether the Fed will nudge rates up a little right away. It looks increasingly like its longer-run rate projections are going to have to come down, or it risks being deeply out of sync with the market. In light of market turmoil of late, Fed officials might also amplify their message that rate increases, whenever they do come, will be gradual.

The era of near-zero interest rates might still end this year, but the era of very low rates isn’t going away any time soon.

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