The 1% Solution

The Fed Whisperer

A move that lacks a rational explanation invites another kind.

There's nothing quite like a juicy bond-market conspiracy theory.

The latest one making the rounds, courtesy of conspiratorially minded traders, is that a small clutch of investors is trying to signal to the Federal Reserve that it's just fine to raise benchmark U.S. interest-rates at its March meeting. 

This hypothesis was ginned up to explain some sudden hard-to-understand activity in interest-rate derivatives Monday that stemmed from little news. In the span of a few hours, futures traders substantially boosted the market-implied probability of a March rate hike, from a 40 percent likelihood to 50 percent. As Edward Bolingbroke of Bloomberg News pointed out, trading in the contracts was chunky and elevated. 

Wind Shift

Traders lifted their expectations for a March Fed rate increase on Monday

Source: Bloomberg's WIRP function

Some attributed the move to remarks by Dallas Fed President Robert Kaplan, who reiterated his view that policy makers should raise rates "sooner rather than later," but that explanation struck many as relatively weak.

Probability Games

Derivatives traders have been pricing in a greater chance of a March rate increase

Source: Bloomberg

Implied USD overnight indexed swap rate as of the coming Fed meeting

Enter the conspiracy theory. There's a growing feeling that the Fed will only raise rates if debt traders are fully pricing it in. Just in case there was any doubt, Cleveland Fed President Loretta Mester said on Bloomberg Television last week, “We certainly never want to surprise the markets.”

As Bianco Research's Jim Bianco said in a recent Bloomberg News article, “The market recognizes it has a veto over the Fed.”

History seems to support this impression. In a Feb. 24 report, Citigroup analysts highlighted that Fed fund futures traders were pricing in more than a 50 percent chance of a rate increase three weeks before the last two moves and more than a 70 percent chance in the week before.

Green Light

The Fed's recent interest-rate increases were priced in before they happened

Source: Bloomberg's WIRP function tracking Fed funds futures contracts

Note: March data is implied as of Feb. 28

"If the Fed wants to move in March, it would have to guide the market toward a higher probability" than is currently priced in, the Citi analysts wrote in that report.

So if a big firm wanted the Fed to raise rates sooner, it could hypothetically encourage it to do so by pushing around markets. This is especially true now, when it's clear the central bank is looking for opportunities to tighten monetary policies but doesn't want to roil the markets. A thumb on the scale from the debt market might be all it takes. 

Is there any evidence that a big player is pulling levers behind a curtain somewhere, cackling maniacally? No, but that's what makes a conspiracy theory so juicy to begin with.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

    To contact the author of this story:
    Lisa Abramowicz in New York at

    To contact the editor responsible for this story:
    Daniel Niemi at

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