- With Dec. rate increase seen almost certain, 2016 is new focus
- Morgan Stanley gauge, futures back case for gradual rate path
With a December interest-rate increase seemingly in the bag as far as investors are concerned, bond traders are now looking to Wednesday’s Federal Reserve meeting minutes for clues on how quickly policy makers plan to raise rates back toward historical levels.
Futures trading indicates the federal funds rate will reach about 0.79 percent by December 2016, while Morgan Stanley’s Market Implied Pace of Rate Hikes Index suggests the Fed will carry out three 0.25 percentage-point rate increases next year. The Federal Open Market Committee meeting minutes are scheduled to be released at 2 p.m. in Washington Wednesday.
The Fed is navigating uncharted waters as it tries to step back from more than six years of virtually zero interest rates. A bevy of policy makers have promised in recent speeches that rate increases would be gradual in order to give inflation more time to rise toward the 2 percent target.
“The market so far is assuming that a gradual pace of rate hikes means once a quarter,” said Subadra Rajappa, head of U.S. rates strategy at Societe Generale SA. “Even some members that have been on the fence as to if the Fed should hike in December have said there will be a big discussion around the pace of hikes at the December meeting. So I’d be curious to see how their thought process around the pace of hikes has changed.”
SocGen, one of 22 primary dealers that trade with the Fed, is predicting a rate increase in December followed by three more in 2016. Overnight index swaps show the fed funds effective rate, currently at 0.13 percent, will reach about 0.74 percent one year from now.
Traders are also hoping to gain more insight on how exactly the Fed will use new policy tools, including the reverse-repo program, to raise rates after officials said in July they would like to provide operational details before taking steps to tighten policy.
"That’s a pretty clear indication that more detail is a necessary precondition before liftoff," said Tom Simons, a government-debt economist in New York at Jefferies Group LLC, also a primary dealer.
The FOMC’s main tool to telegraph the pace of future rate rises is its "dot-plot," a series of quarterly interest-rate forecasts from individual officials. The committee’s projections from September show officials expected to raise rates by about one percentage point each year to 3.4 percent by the end of 2018, from 0.4 percent at the end of 2015.
Kumar Palghat, who runs a bond fund with Bill Gross, said the market is “worried” about the prospect of interest-rate increases by the Fed, partly because it’s not clear how high they will eventually go and how long it will take.
“The question is, once they start going, where do they end up?” Palghat said at a Bloomberg Summit in Sydney. He co-manages Janus Capital Group Inc.’s Global Unconstrained Bond Fund with Gross. “It’s a very difficult environment to be in fixed income.”
The yield on 10-year Treasuries was little changed at 2.27 percent as of 7:44 a.m. New York time, compared with 2.04 percent on Oct. 27, the day before the Fed’s latest decision.