Tags: federal reserve | lacker | interest rate | hike

Lacker: Investors May Be Underestimating Fed Tightening Pace

Monday, 04 August 2014 07:43 AM

Investors may be underestimating the pace at which the Federal Reserve will raise interest rates over the next two years, said Jeffrey Lacker, president of the Federal Reserve Bank of Richmond.

Short-term interest-rate markets have for months priced in a slower tempo of increases than policy makers themselves forecast. That’s risky because the misalignment, a bet against a rate path that the central bank alone controls, could lead to volatility if traders have to adjust rapidly, Lacker said.

“When there is that kind of gap, it gets your attention,” Lacker, a consistent critic of the Fed’s record easing who votes on policy next year, said in an Aug. 1 interview at his Richmond office overlooking the James River. “It wouldn’t be good for it to be closed with great rapidity.”

Futures contracts on the federal funds rate show investors see a 62 percent probability that the benchmark will be 0.75 percent or lower at the end of 2015, less than the 1.13 percent median prediction issued by Federal Open Market Committee participants in June.

Lacker said the discrepancy may arise from skepticism about Fed officials’ forecasts, which call for for unemployment to fall to 5.4 percent to 5.7 percent at the end of next year, close to their estimated range for full employment.

Investors may also be giving too much credence to a phrase in the Fed’s statement that even after employment and inflation are close to its goals, “economic conditions may, for some time, warrant keeping the target federal funds rate below levels the committee views as normal in the longer run.”

More Weight

“They may be placing more weight on that than I think it deserves,” said Lacker, who dissented against his colleagues at every meeting of the FOMC in 2012. “They may think we have more conviction about that than we do.”

U.S. central bankers continued to trim their asset-purchase program last month and said disinflation risks had subsided. They also said that although the unemployment rate had fallen, a range of other indicators indicate “significant underutilization of labor resources.”

Employers added more than 200,000 jobs for a sixth straight month in July, the longest such period since 1997, a Labor Department report showed last week. The jobless rate climbed to 6.2 percent as more people entered the labor force in search of work.

Policy makers in June forecast they would raise the fed funds rate above zero sometime next year, without specifying a month. Federal funds futures contracts show about a 57 percent probability that the rate will be 0.5 percent or higher by July 2015.

‘Well Behind’

“The market is about in line with the Fed in terms of the timing of the first rate hike — somewhere around June — but is well behind in terms of the pace of tightening,” said Roberto Perli, a partner at Cornerstone Macro LP in Washington.

Central bankers also predicted the rate would be 2.5 percent at the end of 2016. Options on Eurodollars futures, which are more actively traded than federal funds rate futures in longer-term contracts, show a 69 percent probability that the rate will be lower than 2.5 percent.

“If the Fed proceeds according to its projections, the bond market, especially at medium and short maturities, would have to adjust a lot,” said Perli, a former Fed economist. That would create volatility not just in rate markets “but also in stock and currency markets.”

Yields on the U.S. 10-year Treasury note were at 2.49 percent late on Aug. 1, down from 3 percent at the start of the year. The drop has occurred in the face of steady job gains and a pickup in inflation to 1.6 percent for the 12 months ending June, according to the personal consumption expenditures price index, from 1.2 percent in December.

Yellen Testimony

Fed Chair Janet Yellen reminded investors in her July testimony to Congress that if labor markets improve more rapidly than the committee expects, increases in the federal funds rate would probably occur “sooner and be more rapid than currently envisioned.”

Even so, investors are focusing on Yellen’s emphasis on labor-market slack — measured by a range of indicators and not just the decline in the unemployment rate — and her intent to keep policy loose until it is reduced, said Joe LaVorgna, chief U.S. economist at Deutsche Bank Securities in New York.

Meanwhile, leverage is building in the financial system, and if the Fed does raise rates at a faster pace than the market expects, “it is going to be messy,” LaVorgna said.

“Rates are at zero, the balance sheet is massive, and you haven’t raised rates since 2006,” he said.

© Copyright 2020 Bloomberg News. All rights reserved.

1Like our page
Investors may be underestimating the pace at which the Federal Reserve will raise interest rates over the next two years, said Jeffrey Lacker, president of the Federal Reserve Bank of Richmond.
federal reserve, lacker, interest rate, hike
Monday, 04 August 2014 07:43 AM
Newsmax Media, Inc.
Newsmax TV Live

Newsmax, Moneynews, Newsmax Health, and Independent. American. are registered trademarks of Newsmax Media, Inc. Newsmax TV, and Newsmax World are trademarks of Newsmax Media, Inc.

© Newsmax Media, Inc.
All Rights Reserved