Tags: Federal Reserve | interest rates | volatility | VIX

Fed Research Shows Investors Underestimate Path of Rate Rise

Monday, 08 September 2014 03:57 PM

Low volatility across financial markets may signal investors are underestimating how quickly the Federal Reserve will raise interest rates, according to researchers at the San Francisco Fed.

“Surveys, market expectations, and model estimates show that the public seems to expect a more accommodative policy than Federal Open Market Committee participants,” Jens Christensen, a senior economist, and Simon Kwan, a vice president of financial research, said in a report today. Data also suggest that the public is “less uncertain about their projections.”

Fed officials in their June economic forecasts predicted their target interest rate will be 1.13 percent at the end of 2015 and 2.5 percent a year later. They are set to release updated projections Sept. 17. Federal funds rate futures are pricing in the first interest-rate increase in October 2015.

Expectations for the future path of the funds rate are a concern for Fed officials preparing to raise the main rate, which has been held close to zero since December 2008. Jarring markets with faster-than-expected increases could disrupt the five-year-old economic expansion.

Another concern: “The public might not give enough weight to how dependent the central bank’s guidance is on both current and incoming data,” the researchers wrote. “Thus, the public could underestimate the conditionality and uncertainty of interest rate projections.”

Indicators of future volatility in some asset markets “have fallen to low levels, suggesting that some investors may underappreciate the potential for losses and volatility going forward,” Fed Chair Janet Yellen said in a July 2 speech.

Volatility Tumbles

Volatility across stocks, bonds and currencies worldwide has tumbled to record or multi-year lows this year. The Chicago Board Options Exchange Volatility Index fell in July to a seven- year low of 10.32. Swings in global currencies fell to a record low earlier this year, and Treasury fluctuations moderated to near their all-time narrowest.

“Prices of financial assets, such as stocks and bonds, are sensitive to unexpected changes in interest rates because their present values are determined by discounting future cash flows,” Christensen and Kwan wrote. “Low volatility in asset markets could, in part, reflect market participants’ relative certainty about the future course of interest rates.”

Research shows rate forecasts in the quarterly Summary of Economic Projections “can better align the public’s and the central bank’s expectations” and help improve macroeconomic performance, the researchers wrote.

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Economy
Low volatility across financial markets may signal investors are underestimating how quickly the Federal Reserve will raise interest rates, according to researchers at the San Francisco Fed.
Federal Reserve, interest rates, volatility, VIX
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2014-57-08
Monday, 08 September 2014 03:57 PM
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