MacroScope

Fed speaks, but does market listen?

January 30, 2013

Jonathan Spicer contributed to this post

When the Fed adopted thresholds for its low interest-rate policy last December, Fed Chairman Ben Bernanke said they would make “monetary policy more transparent and predictable to the public.” But now that the policy is fully in place, it doesn’t seem that the public and the Fed are predicting the same thing at all. Not even close.

In their policy statement following a two-day meeting that wrapped up Wednesday, Fed policymakers removed any reference to date-based policy guidance, saying only that exceptionally low rates would remain in place as long as unemployment remains above 6.5 percent and inflation is not seen to top 2.5 percent. But as recently as December, the Fed’s statement suggested policymakers did not believe those thresholds would be met until at least mid-2015.

The market, as personified by traders ofU.S.short-term rate futures at the Chicago Board of Trade, believes differently. According to CME Group’s FedWatch, which uses fed fund futures prices to estimate market expectations, traders were pricing in a 55 percent chance of a first rate hike by October 2014 – eight months before the Fed’s forecast last month. Threshold-based policy does not seem to have brought the market and the Fed onto the same page – not even to the same year.

Craig Dismuke, chief economic strategist at Memphis-based broker-dealer ViningSparks, has an explanation. “The minutes from the December meeting, where some are thinking about trying to end asset purchases earlier than expected – I think there’s this idea that there’s a little more hawkishness to the Fed than some people thought maybe at the beginning of December,” he said.

In addition, inflation expectations, as measured by trading in 5-year inflation-protected bonds, have risen over the past month. ”As those inflation expectations go up, which I think is natural as the economic data looks better, people are moving in their belief of how long the Fed can sit on the sidelines. You have to price in a greater likelihood that inflation begins to rise sooner. I think that’s what’s happening.”

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