Markets Don’t Believe the Fed
The U.S. Federal Reserve faces a challenge as it prepares for its regular policy-making meeting today: After the worst start of a year on record, markets simply don't believe the central bank will tighten in 2016 as much as it has indicated.
Throughout January, Fed officials have been careful to note that the market rout doesn’t necessarily change their outlook for the U.S. economy. As of December, they expected growth to be strong enough to allow the central bank to raise its target rate significantly this year: Their median forecast for December 2016 was 1.375 percent -- the equivalent of four 0.25 percentage point increases from the current level of between 0.25 and 0.50 percent.
Markets never bought that forecast, and they buy it even less now. As of Tuesday afternoon, futures prices suggested that the central bank's target rate would reach only 0.6 percent by December -- indicating no more than one rate increase. At the end of 2015, the market still expected two rate hikes. Here's a chart showing the gap between the Fed's and the market's expectations:
Interestingly, futures prices also imply about a 32 percent chance that the Fed won't raise rates at all this year. That's up from just 6 percent at the end of 2015. Here's how that looks:
So what is the market trying to say? One possibility is that traders are counting on a "Yellen put" -- a policy originally attributed to former Fed Chairman Alan Greenspan, in which the central bank steps in to prop up markets and rescue investors. Another is that they think the market turmoil reflects a deeper economic malaise, perhaps emanating from China, which will force the Fed to maintain stimulus.
The Fed has rightly sought to disabuse investors of the notion that protecting them from their mistakes should be part of its job. That said, if concerns about the economic outlook prove correct, or if the market gyrations lead companies and consumers to spend and invest less, the central bank may have to respond.
As Bloomberg View has noted, giving longer-term guidance in this environment is a fraught enterprise. Before the economic data are in, it will be difficult -- and possibly counterproductive -- to convince markets that rates will rise. The best Fed officials can do is make it clear that they will have to wait and see.
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