Fed's Latest Rate Forecasts Still Deemed Too High by Traders

Updated on
  • Policy makers keep moving outlook down toward market level
  • Gulf remains as traders lower interest-rate outlook too

Most Important Two Minutes of the Fed News Conference

Federal Reserve officials are once again coming around to the bond market’s view that interest rates will stay lower for longer.

The central bank held its benchmark rate near zero Thursday, showing policy makers think inflation still has a way to go to reach their 2 percent target amid an uncertain outlook for global economic growth.

For every quarter in 2015 Fed officials lowered projections for the funds rate in coming years. Yet their forecasts are still more aggressive than the path expected by most traders. While the median projection from Fed officials signals a rate increase by year-end, fed fund futures show traders anticipate the central bank may wait until 2016.

“The markets never really bought the Fed story to begin with,” said Michael Arone, the Boston-based chief investment strategist at State Street Global Advisors’ U.S. Intermediary Business. The firm oversees $2.4 trillion. “The markets have been consistently below the dot plot in the rate expectations, and now the Fed seems to be coming a little bit more into the market reality from that standpoint.”

Officials cut their median estimate for the fed funds rate at the end of 2016 to 1.4 percent, from the June forecast of 1.6 percent. A year later the median of officials’ forecasts rises to 2.6 percent, down from the June projection of 2.9 percent. The central bank lowered its long-run rate to 3.5 percent from 3.8 percent.

Ripple Effect

Money-market derivatives indicate the fed funds effective rate will average 0.58 percent in a year, 1.13 percent in two years and 1.56 percent in three years. The Fed has held its target for the rate in a range of zero to 0.25 percent since December 2008.

“The Fed has consistently projected rates as moving higher than what the market does," said Scott Minerd, who oversees $240 billion as global chief investment officer at New York-based Guggenheim Partners LLC. "So far, the market has been right.”

Slowing economic growth in China, the world’s second-biggest economy, has rippled across the globe. The MSCI Emerging Markets Index, which includes nations such as Brazil and China, is down about 13 percent this year.

Futures traders are pricing in about an 18 percent probability the central bank increases it target range in October, a 44 percent chance by the December meeting and a 53 percent likelihood by January. The calculation is based on the assumption that the effective fed funds rate will average 0.375 percent after the first increase, near the mid-point of the range. Fed funds futures signal the rate moving to 0.21 percent by year-end.

“Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term,” the Federal Open Market Committee said in a statement in Washington.

At their June meeting, Fed officials cut their median forecast for the funds rate for the end of 2016 to 1.625 percent from 1.875 percent. At the time, the level implied by futures contracts maturing at the end of next year fell to 1.1 percent from 1.5 percent.