Amid the improvements in the US job market, the Federal Reserve’s regional bank presidents are mulling over whether to push interest rates up from zero sooner than actually planned.
The insiders say most Fed officials at June’s policy meeting didn’t see rate increases until 2015.
Observing the improving US economy, Federal Reserve Bank of Philadelphia President Charles Plosser has said that the central bank needs to prepare markets for the probable condition when short-term interest rates may come sooner than many currently expect.
While talking to a journal, Plosser said, “We need to adjust the language in our statement to reflect that the economy really is better that it was, and that the necessity of having zero interest rates for a long time to come seems to me to be perhaps a risky or unnecessary step at this point.”
He further said that he is still unclear that whether there is a need to tighten policy right now. “The economy has improved in a way that central bankers need to get ready for the coming end to the Fed’s ultra-easy money stance, he said.
On Wednesday, the treasury bonds rose for a third straight session following the minutes of the Federal Reserve’s June policy meeting that suggested the central bank is in no rush to raise interest rates.
The 10-year yield climbed to 2.601 percent.
In the June policy meeting, Fed proposed ending its bond-buying program by October if economic growth continues to gain traction.
According to the Fed officials, growth is expected to bounce back from the soft patch in the first quarter, taking note of improvement in employment. However, wage pressures still remain tame, giving the Fed more time in raising interest rates.
“The bond market reacted favorably to the minutes, because the Fed continues to convey a sense that it will be patient with respect to its removal of its extraordinary monetary accommodation,” said Tony Crescenzi, senior market strategist at Pacific Investment Management Co. in Newport Beach, Calif., which has USD 1.94 trillion in assets under management.
Understanding Interest rates-bond prices relation
The interest rates and bond prices are inversely related, i.e. when interest rates fall, bond prices usually rise and vice-versa.
A bond’s yield rise when the value of the bond declines. Therefore, when bond yields or interest rates rise, it implies the value of bonds in general is declining. This is the reason why rising bond yields are generally undesirable for existing bond investors.
What do the Crediting rating agencies say?
Crediting rating agencies JPMorgan and Goldman Sachs expect the first Fed rate hike during the third quarter of 2015. Other rating agencies have also joined the chorus.
The interest rate futures markets mean a funds rate of 50 basis points in September and 72 bps by December. The funds rate of 1.7 percent is expected by the end of 2016. But the bond market remains lagging behind the median estimates of FOMC members. The slow pace of bond market projects 1.13 percent and 2.5 percent funds rate at the end of 2015 and 2016 respectively.
John Brady, a managing director at RJ O’Brien: The worst central banking scenario is tightening too soon. The dovish members of the FOMC are very mindful that without sustainable wage growth, higher inflation will prove temporary. That is what the bond market is telling you at the moment.
Luke Bartholomew, investment manager at Aberdeen Asset Management: Once the Fed’s quantitative easing ends, it’s going to quicken the debate about exactly when US interest rates might rise.
Paul Ashworth of Capital Economics: There is scope for markets to be surprised should the BoE and Fed change course, that’s the nature of monetary policy. But unlike past rate hike periods, the eventual peak will be lower. Both BoE and Fed officials have stressed that they will raise rates gradually and the neutral rate will be lower. The wage and price inflation will accelerate over the rest of this year. This may be the reason why he expects a rate hike in March 2015. The funds rate is expected to climb to 1.25 percent by the end of next year and 3 percent by late 2016.
David Kelly, chief global strategist at JPMorgan Funds: A tightening labour market combined with improved business and worker confidence should cause wage growth to accelerate. It is hard to see how the Fed can get back to normal quickly enough to avoid asset bubbles or inflation or slowly enough to avoid a significant adjustment to the bond market.
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