Nomura Says September Rate Rise Would Be Most Dovish in History

Traders say it’s a coin toss whether the Federal Reserve raises interest rates from near zero next month. They’re more sure policy makers won’t be in any hurry once they get started.

Futures prices show 48 percent odds the Fed hikes in September, even as plunging commodity prices drag down inflation expectations and China’s currency devaluation signals a slowdown in global growth. An imminent Fed rate rise amid broader uncertainty shifts scrutiny to the pace of subsequent increases. Officials have repeatedly lowered their own projections, known as the dot plot, for how quickly and how high rates will go.

“If they go in September, it will be the most dovish hike they have ever administered,” said George Goncalves , head of interest-rate strategy at Nomura Holdings Inc., one of 22 primary dealers that trade directly with the Fed. “They will lower the dots and they will say this is really just operational to get off of zero.”

The Fed’s overnight rate is not expected to reach 1 percent until December 2016, according to futures prices, suggesting monetary policy will change at a gradual pace. That compares with policy makers’ own median forecast of 1.625 percent at that date.

‘Weak’ Inflation

Treasury 30-year bond yields, which are linked to the longer-term outlook for growth and inflation, fell to 2.84 percent Friday in New York from 3.20 percent a month earlier. The one-year break-even rate, a bond-market inflation gauge, fell to the lowest since May 2009.

Goncalves said the U.S. economy appears immune to every source of inflation pressure, including a robust labor market. He forecasts the Fed to raise rates in December.

“We’ve had weak commodities, weak inflation, mixed data,” Nomura’s Goncalves said. “Yes the job market’s good, but create as many jobs as you want, it’s not creating inflation.”

Traders are pricing in a a 74 percent chance of a Fed rate increase by December, based on the assumption that the effective fed funds rate will average 0.375 percent after liftoff. The 48 percent probability the Fed increases at its September meeting is up from 40 percent on Aug. 11, when China devalued its currency by the most in two decades.

‘Big Country’

Inflation expectations for the next five years have fallen almost half a percentage point since May 1 to 1.28 percent, bond yields show. The expectations for the five years after that have held below 2 percent, suggesting the bond market is skeptical the Fed can lift inflation to its target during the next decade.

Economists at the world’s biggest bond shops continue to cut expectations for how high Treasury yields will go, saying benchmark 10-year yields won’t reach 3 percent until the fourth quarter of next year, according to a Bloomberg News survey. As recently as December they were calling for 10-year yields to top 3 percent by year-end. The Treasury 10-year note yielded 2.20 percent Friday.

While the U.S. economy has shown signs of stability, the Fed is trying to raise rates as other central banks keep borrowing costs low and weaken their currencies.

“The U.S. is a big country, it can stand by itself” with higher rates, said David Keeble, New York-based head of fixed-income strategy with Credit Agricole SA. Higher rates will “be a positive development, not a negative one,” he said.

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