September 12, 2016

Janet Yellen will deliver the biggest shock to markets since taking over as chair of the Federal Reserve should the central bank raise interest rates this month, according to a survey of Wall Street economists that shows more than 85 per cent expect it to hold fire.

The scepticism among economists may concern the Fed’s top officials, who have spent the past month trying to persuade financial markets that an increase at their meeting on September 21 is a possibility given that the US unemployment rate is below 5 per cent and the global fallout from the Brexit vote has been muted.

They have succeeded at least in jolting financial markets out of months of complacency, after comments from two voting members on the Fed’s policy-setting committee on Friday sent US stock and bond prices sliding at their greatest rate since June.

Conviction that Fed policymakers, who in January were projecting four rate rises this year, will tighten policy has been drained by a run of mixed US economic data, including slower jobs growth in August and signs that the services sector has lost momentum.

Just 13 per cent of the 46 economists surveyed by the Financial Times forecast a rise in the central bank’s key short-term interest rate this month. Interest-rate futures suggest a 30 per cent probability that the Fed will move this month, a gauge of trader expectations that historically has been more sceptical than economists of the Fed’s appetite to raise interest rates.

However, some believe the Fed’s willingness to move this month, even if it is not currently priced in by markets, is underestimated.

“Given the recent communication from Fed officials, who have begun to signal that another hike in the near term is appropriate, we think the market has become too complacent,” according to economists at Goldman Sachs.

Speculation the Fed will make a last-ditch effort to lift the market’s expectations of a move in 10 days have been stirred after it emerged late on Thursday that Lael Brainard, a Fed policymaker seen by investors as in no hurry to raise rates, is giving a speech in Chicago on Monday, the final day before a blackout on officials’ public comments before the meeting comes into force.

“We also see some risk that she could deliver a speech with a hawkish tilt,” according to economists at Barclays, who predict the Fed will move. “If Federal Reserve chair Yellen wants to increase the market-implied probability of a rate hike, this speech is one of her last opportunities.”

An increase next week by the Fed would be a major blow to this year’s rally in fixed income, which has been slowed in recent weeks by speculation over the conclusions of the Bank of Japan’s review of its unconventional policy which it will deliver on the same day the Fed gives its decision.

Bond yields were also pushed higher after European Central Bank president Mario Draghi said on Thursday that officials had not even discussed extending the central bank’s own quantitative easing programme, which is in danger of running out of bonds to buy.

The yield on the benchmark Japanese 10-year bond is close to positive territory again after falling as low as negative 0.29 per cent in late July; the 10-year German Bund rose above zero for the first time since July on Friday, while the yield on the 10-year US Treasury has risen from a record low of 1.32 per cent to 1.68 per cent.

Jeffrey Gundlach, the founder of DoubleLine Capital and an influential bond investor based in Los Angeles, told Reuters on Thursday that the Fed would be prepared to raise rates if interest rate futures put the odds at more than 40 per cent. “They want to show that they are not guided by the markets.”

The Fed’s first rate increase since the financial crisis came last December, when markets had priced in an almost 80 per cent chance of the move.

More than 77 per cent of those economists polled by the FT, including several who forecast the Fed will go this month, believe the central bank will only raise once this year.

Several also downgraded their expectations for further tightening from the Fed next year, the survey found. The median projection showed two further increases, taking rates to 1.125 per cent. However, the share of economists expecting more than half a percentage point of additional tightening in 2017 fell to 20 per cent from 30 per cent in the FT’s last survey in July.

The FT conducted its survey between September 6 and 9.

The Fed was also seen as unlikely to turn to negative rates if the US economy required further stimulus. More than half said they believed the US central bank had ruled out negative interest rate policy after its rollout in Europe and Asia plunged yields on more than $13tn of assets below zero and intensified risks for the financial sector. 

eric.platt@ft.com

Twitter: @ericgplatt



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