Global Indicators Point to Fed Reversal
The Bank of England voted unanimously not to raise interest rates Thursday, as the sole dissenter on the Monetary Policy Committee abandoned his recent calls to tighten policy. The European Commission also slashed its inflation forecasts, all but guaranteeing more quantitative easing when the European Central Bank next meets in March. Now, given the world's deteriorating economic backdrop, that December rate increase from the Federal Reserve looks increasingly anachronistic.
Mark Carney, the U.K. central bank chief, cited "an unforgiving global environment and sustained financial market turbulence" as one reason not to push up borrowing costs. Here's what happened in the past six months to a Morgan Stanley index showing what market prices say about how long it will be until U.K. rates rise:
So, at the start of the year, an increase in the current U.K. bank rate of 0.5 percent was baked in. Now, the market is saying it'll be almost three years -- 30 months -- until Carney can pull the trigger. Indeed, market prices increasingly predict a rate cut by the end of this year. Here's how those expectations have developed in what's called the overnight index swaps market:
At his press conference, Carney dismissed the possibility, saying policy makers are unanimous in anticipating that their next move will be an increase. Yet, in November, his chief economist, Andy Haldane, suggested that the bank should be prepared to "move off either foot depending on which way the data break."
The global data, it must be said, don't back a rate increase. The European Commission slashed its forecast for euro-region inflation this year to just 0.5 percent, down from its November prediction for 1 percent and miles away from the ECB's 2 percent target. Here's what ECB chief Mario Draghi had to say Thursday about the outlook for consumer prices:
There are forces in the global economy today that are conspiring to hold inflation down. Those forces might cause inflation to return more slowly to our objective.
How does all this leave the Fed after its rate rise in December? I'd suggest that move increasingly looks like a policy error that might have to be reversed. The futures market now reckons there's just a 10 percent chance of a second increase when the Fed meets next month, down from a more than 50 percent likelihood at the start of the year:
Moreover, the odds from traders and investors don't suggest the Fed will impose higher borrowing costs at its later meetings this year:
So here's a prediction. That right-hand column in the table above -- measuring the likelihood of a Fed reversal -- has zeroes from here to the end of the year. In the coming months, some of those zeroes may disappear -- as the market starts to bet that the December increase will be taken back.
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