The Fed Fights the Tape Over Interest Rates

Despite the Federal Reserve’s protests to the contrary, the market remains unconvinced a rate increase is coming

By Justin Lahart

Federal Reserve Bank of Boston President Eric Rosengren recently warned investors that markets are too sanguine on the prospect of a rate increase. Photo: Associated Press   

The Federal Reserve is having a hard time convincing investors of its rate plans this year. The Fed deserves at least part of the blame.

One thing investors and the Fed agree on is that the central bank won’t be raising rates at its policy meeting this week. Federal-funds futures, which price off of overnight-rate expectations, ascribe virtually no chance of it. And the Fed has been unusually clear about its intention to stay on hold.

June is a different matter altogether.

Projections released after the Fed’s March meeting showed policy makers expect to raise rates twice this year, taking the midpoint of their target range to 0.875%. The Fed’s June gathering, which will include a postmeeting news conference, is natural for a first move.

But as of Friday, fed-funds futures implied less than a 20% chance of a June move. And rather than two rate increases this year, the futures imply at most one, with about a 10% chance of no move at all. The rate-increase odds were even slimmer at the outset of last week, before Eric Rosengren, the usually dovish president of the Federal Reserve Bank of Boston, again warned markets were too sanguine.

Curiously, if you ask around, most people seem to be on board with the Fed’s rate forecast. Three-quarters of the economists in The Wall Street Journal’s latest forecasting survey look for a June increase. And the majority of big investors polled by the Federal Reserve Bank of New York last month also favored a June move.

But those trading futures obviously have different ideas. This might be partly because survey respondents are saying what they think will probably happen, but traders are dealing with probability. If a trader thinks the Fed will probably move in June, but there is some chance it won’t, that chance will get reflected in prices the trader is willing to pay.

Another factor in the futures pricing, notes RBC Capital Markets rate strategist Mike Cloherty, is that betting against the Fed hitting its projection has been a pretty consistent way to make money. So, at this point, traders have an ingrained bias to take the under versus the Fed.

Finally, a big reason the Fed has undershot is that its projections have often seemed built on the assumption nothing would go wrong. It then has to dial back when things do go wrong. This tendency has been particularly pronounced because the Fed thinks raising rates too fast is a greater risk than raising them too slowly.

With even doves like Mr. Rosengren and Federal Reserve Bank of Chicago President Charles Evans apparently comfortable with two rate increases, the Fed’s projections seem more likely to come true than in the past.

The Fed’s job between now and June: convince traders of this without eliciting the sort of worried market reaction that could push the next rate increase further into the future.

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