Investors Keep Guessing Wrong About the Fed's Rate Moves

The Federal Reserve keeps saying it’s going to raise interest rates. The markets keep believing it. And then rates stay glued to the floor. That’s been the pattern since at least 2008, early in the devastating recession, as this remarkable chart from Deutsche Bank Securities shows.

Source: Deutsche Bank Securities

The underlying problem has been overoptimism about the economic outlook. Again and again, the members of the rate-setting Federal Open Market Committee have prematurely predicted that the economy will gain strength, justifying higher interest rates. Each year their hopes have been dashed. Investors haven’t quite believed the Fed, but even so, they have bet on somewhat higher rates.

The red line in the chart above shows what’s actually happened to the federal funds rate, the short-term lending rate the Fed controls. The dotted black lines are the projections at different points in time for the trajectory of the federal funds rate. For example, in mid-2008 the funds rate briefly flattened out at 2 percent. At that point, investors in the fed funds futures market were betting on it to rebound to more than 3 percent in 2009. Instead, it plummeted to just above zero.

Torsten Slok, Deutsche Bank’s chief international economist, predicts in a note to clients today that rates really will rise in 2015, because the U.S. economy is gathering strength. But Slok also admits, “The chart … makes you humble when it comes to the timing of the first rate hike.” It sure does.

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