The Fed: Fed watchers scoff at speculation of half-point rate hike next w…

The Fed: Fed watchers scoff at speculation of half-point rate hike next w…

Fed watchers scoff at speculation of half-point rate hike next week

Fed Chairman Jerome Powell has stressed he will take a gradual approach similar to his predecessor Janet Yellen.

Probabilities of U.S. central bank interest-rate moves tracked by the Atlanta Fed regional bank suggest investors see an 11% chance of a 50-basis point rise at next week’s rate-policy meeting.

That’s based on the regional central bank’s model that uses data on three-month Eurodollar futures, options on three-month Eurodollar futures from the Chicago Mercantile Exchange, three-month Libor/fed funds basis swap spreads expiring in 12 months, and the Treasury yield curve.

On its face, that’s a startling bet. New Fed Chairman Jerome Powell has spent considerable time in his first public appearances assuring investors he plans to follow the gradual rate hike patch set out by his predecessor, Janet Yellen. As a result, a 25-basis-point move on March 21 has been widely anticipated.

Read: Fed says it is still planning to raise interest rates gradually

Could Powell and his colleague surprise the market and act more aggressively out of concern that the central bank is falling behind the curve on inflation?

The answer from economists: no way.

Such a large move from the Fed would be an outlier: The last 50-basis-point rate hike was almost 18 years ago in May 2000, when policy makers pushed the fed-funds rate up to 6.5%.

It is true that the real, or inflation-adjusted, fed-funds rate remains negative, which means it is below the rate of inflation. That’s the way it has been for nine years of expansion following the Great Recession. This means the Fed still has its foot on the gas to boost the economy, even though many expect the Trump tax cuts and higher government spending will push up growth this year.

Mickey Levy, chief economist at Berenberg Capital Markets, is one analyst who is worried that the Fed might get caught “flat-footed” by a resurgent U.S. economy. He thinks the Obama administration tax and regulatory environment “threw a cold blanket over the economy” that Trump’s policies are helping to remove.

But even Levy sees no chance of a 50-basis-point move.

“There is no reason to” turn aggressive, Levy said in a phone interview. A bigger move would surprise and upset the stock and bond markets and would risk harming the economy’s momentum, he said.

Even if growth is picking up, as he expects, the Fed won’t know for some time how much of the acceleration is sustained or temporary.

“For that reason alone, they wouldn’t want to do 50 [basis points],” he said.

Stocks and bonds have become more volatile in recent weeks. Boston Fed President Eric Rosengren said investors are starting to realize there is a risk that unsustainably strong growth that leads to excess inflation is now as much a risk as growth that falls short.

The 10-year Treasury yield TMUBMUSD10Y, -0.96% is now trading at 2.81%. The Dow Jones Industrial Average DJIA, -1.02% has retreated from the record closing of 26,616 set on Jan. 26.

Thomas Simons, money market economist for Jefferies, said the Atlanta Fed’s tracker may just be picking up reaction to expectations of higher Treasury issuance to pay for fiscal largesse. The fed-funds rate trades within a band. So investors could be thinking that the effective fed-funds rate is going to float higher relative to the upper and lower bound, rather than the midpoint, he said.

Jeffrey Cleveland, chief economist at Payden & Rygel, agreed. “I don’t think any actual market participants are expecting a 50-bps rate rise nor are they betting on one,” he said in an email.

“The 11% figure could be a quirk…[reflecting] what’s going on in the markets as we approach quarter end, etc. It is not necessarily a pure reflection of what people are thinking about the Fed,” Cleveland said.

Inflation is still below the Fed’s 2% annual target and February retails sales “were not so hot,” Simons said. In addition, there are no signs wages are accelerating or the economy is overheating.

“There is no logical thread for investors to put together to get a 50-basis-point rate hike next week,” Simons said.

Related Topics

  • U.S. Economy

  • Federal Reserve

  • Housing

  • Employment

  • Inflation

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