Tags: federal reserve | market | forecast | economy

Market Outlook Diverging From Fed's Forecast by Most in Year

Friday, 12 Dec 2014 12:11 PM

Plunging oil prices are driving traders to slash outlooks for inflation, pushing financial market expectations below Federal Reserve policy projections by the most in about a year.

While U.S. labor conditions and growth have improved, expectations for consumer price increases through the end of 2016 as measured by U.S. inflation swaps are at the lowest in over four years. Slowing growth in China to Europe and a glut of oil that has sent the commodity to half-decade lows have dimmed the prospect that steady job gains and consumer confidence will prove enough to lift inflation in the years ahead.

“Where the market is challenging the Fed now is on their inflation forecasts,” said Jim Vogel, a fixed-income strategist at FTN Financial in Memphis. “That’s the primary disconnect. The market is scrambling once every two to three hours to figure out where oil prices are, and what is driving them. The story of the second half of this year is this realization that inflation and inflation expectations are no longer a stable creator or something that can be ignored.”

Fed officials’ central tendency estimate for inflation, measured by the personal consumption expenditure price index, in 2016 was 1.7 to 2 percent, according to its most recent Summary of Economic Projections released in September. U.S. inflation swaps traded in the forward market, when adjusted by the typical spread between consumer price index and PCE inflation, show the market placing PCE, the Fed’s favored gauge, at about 1.5 percent for 2016, according to Vogel.

Oil extended losses below $60 a barrel in New York, falling to a five-year low as the International Energy Agency cut its 2015 demand forecast for the fourth time in five months.

Forward Inflation

Given the slide in oil, the key question is now where markets see forward inflation relative to the Fed’s outlook as opposed to during the first half of the year, when money market traders’ projection of the federal funds rate was key, Vogel said. The majority of Fed officials and private forecasters expect the central bank to begin lifting its zero to 0.25 percent target rate band around the middle of next year.

The median officials’ estimates of where the federal funds rate will be at the end of 2015 was 1.375 percent, and at 2.875 percent a year later. The Fed will release new quarterly projections at next week’s policy meeting.

Central bank officials are discussing the future of their vow to hold interest rates low for a “considerable time,” ahead of the policy meeting, where they will weigh that pledge against signs of economic strength.

The phrase, retained at the Federal Open Market Committee gathering in October when it ended a two-year bond buying campaign, has been used by the Fed to ensure investors that it would maintain stimulus measures.

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Plunging oil prices are driving traders to slash outlooks for inflation, pushing financial market expectations below Federal Reserve policy projections by the most in about a year.
federal reserve, market, forecast, economy
467
2014-11-12
Friday, 12 Dec 2014 12:11 PM
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