CHART OF THE WEEK
The chart of the week indicates the probability that the US central bank will lift rates at its June 15th meeting, as calculated from federal funds futures contracts, financial instruments that allow investors to position themselves in relation to the level of the federal funds rate. Prices for federal funds futures contracts imply that markets currently estimate the probability of an increase in rates at less than 10%, down from around 50% in mid-March.
Our Analysis
Whilst market turmoil was clearly to blame for falling probabilities at the beginning of the year, falling expectations since mid-March have a lot more to do with relatively disappointing first-quarter figures, such as GDP growth of just 0.5%. The unemployment rate, which has stabilised at 5.0% in recent months, is also likely to have had an influence, with the idea being that this gives the Fed more time to normalise its monetary policy. Investors have interpreted the Fed’s March 16th meeting and Janet Yellen’s subsequent comments as a confirmation of this stance.
Until recently, we afforded a rate increase in June significantly higher probability than the market. However, shifts in market sentiment are now making this less likely, especially as the Brexit referendum, a significant risk factor, will be held a few days later. It would take very good figures to be released in the meantime for the situation to change. What remains is that whereas the Fed’s main scenario seems to involve two rate increases by the end of the year, the market considers that there is a 50% chance that the Fed will actually keep policy on hold.
What will the impact of this discrepancy be on the markets? Will the Fed decide to surprise them to regain some latitude or will it wait for macroeconomic data to warrant action? In the first case, volatility could increase temporarily but we believe that the US economy would pick up again in the months to follow. How the markets adjust to the Fed’s main scenario would then become a case in point.
The opinion expressed above is dated May 6th, 2016 and is liable to change.
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