Can We Now Believe The Fed?
After Yellen’s comments and a massive beat to the upside for NFP, the markets are quickly pricing in a rate hike of 25bps for the Federal Reserve’s December meeting. The chart above shows the Fed’s dot plots for their estimates for raising interest rates. They show that members expect the Fed Funds rate to increase to 1.375% by the end of 2016 and to 2.625% by the end of 2017. The OIS (Overnight Index Swaps) show a more dovish estimate by the markets of 1 hike in 2015, 2 hikes in 2016, and 2 hikes in 2017.
Thus, the debate going forward on the Fed is now shifted from when will be the first rate hike to speed of the 2nd or 3rd hike. This is the all-important “pace” by which the Fed raises rates. Will it be gradual as the market believes or will it be more aggressive as the Fed is indicating?
The answer to this question will be determined by subsequent unemployment data with a particular focus on wage gains and inflation. Remember, the Fed won’t need to see outsized gains like October’s data to continue to raise interest rates. Fed’s Bullard on Thursday night said:
“This is not Lake Wobegon. You cannot be above average all the time… I don’t think markets have absorbed this. Everyone has in their head 200,000…The natural expectation is for the pace of job growth to slow in the months and quarters ahead. We are expecting that to happen. It would be normal, and that would not indicate poor macroeconomic performance.”
So while the markets will remain skeptical about the Fed’s pace of rate hikes, I think it’s best to begin to believe that the Fed will hike rates faster than what the market believes.
Originally posted on Andrew Busch’s Website.