Traders Bet on Too Much Fed Predictability, Nomura Says

Money-market traders may be tuning out Federal Reserve Chair Janet Yellen.

Strategists at Nomura Holdings Inc., which predicts the central bank will begin tightening policy in December, say prices on futures contracts pegged to the federal funds rate don’t reflect the signals that Yellen has been sending in recent speeches.

The analysts say the market’s factoring in about one Fed increase every other meeting after the first boost, in the sort of predictable path seen in previous eras. That’s too “linear,” given that Yellen has made clear there will be no consistent pattern for the path of interest rates, according to Nomura, one of the 22 primary dealers that trade with the Fed.

“The market always looks at the previous hiking cycles as a benchmark, but Yellen has focused on a gradual pace with no pre-set course,” Stanley Sun, a New York-based strategist at Nomura, said in an interview Monday. “Some people associate hiking with a hiking cycle, but this time there is almost going to be no cycle.”

The Federal Open Market Committee meets Tuesday and Wednesday to decide on interest rates, and Fed watchers will scour the statement it issues Wednesday for clues to when the first rate increase may occur. The next scheduled meeting for the bank’s policy makers is in September.

Yield Read

The implied yield on December 2015 fed funds futures contracts is 0.31 percent, while the December 2016 contract yields 0.985 percent. The futures settle at expiration to the average for the Fed’s effective rate during the contract month. The effective rate, a volume-weighted average of trades between major brokers, was 0.13 percent on July 24.

In June, Fed officials reduced their median estimate for the fed funds rate at the end of 2016 to 1.625 percent, from 1.875 percent in March.

Economists surveyed by Bloomberg put the likelihood of a September rate increase at about 50 percent. Policy makers have held their target for the fed funds rate -- which commercial banks charge each other for overnight loans -- in a range of zero to 0.25 percent since December 2008.

The Fed may pause for even three to four months between hikes, Nomura analysts led by George Goncalves wrote in a note published July 24. The implied yields on the futures that expire in March and April are as much as 0.10 percentage point too high, they wrote.

“It’s increasingly looking like there will be one increase this year and then pause for a while,” Sun said.

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