MacroScope

Fed makes low rates vow, but traders afraid of commitment

February 3, 2012

Anyone worried that the U.S. Federal Reserve tied its policy hands with its announcement last month that  it is likely to keep short-term interest rates exceptionally low through late 2014 should take heart in the market reaction to Friday’s jobs report, which blew expectations out of the water.

Bond and interest-rate futures plunged after the report, which showed employers added 243,000 jobs in December, far more than the 150,000 economists had expected. Unemployment dropped to 8.3 percent in another encouraging sign. Fed fund futures contracts began pricing in a good chance of a rate hike by the second quarter of 2014. Before the report, bets were on a first rate hike at some point in the third quarter.

Some officials and analysts have publicly worried about the chilling effects of a Fed that signaled low rates for so long, a move they say threatens confidence just as the economy is showing signs of improvement and leaves the impression that the late-2014 date is a commitment.

This is what Charles Plosser, the Philadelphia Fed’s hawkish president who opposed the move, said after the policy decision:

I often read comments in the media that the FOMC has ‘pledged’ or ‘vowed’ to keep rates at zero at least until late 2014. If the economy changes, then that 2014 date will go out the window.

Judging from Friday’s market reaction, it already has. Markets and economic data are never stagnant, and chances are that in due time something will force dealers to pare back expectations once again. Still, at least one thing is clear:  traders aren’t buying the idea that the Fed is promising anything.

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