Traders are betting the Federal Reserve will keep policy easier for longer now that former Treasury Secretary Lawrence Summers is out of the running to succeed Ben Bernanke as chairman of the U.S. central bank.
Summers, a former top aide to President Barack Obama, was widely regarded as likely to be more "hawkish" than current Vice Chair Janet Yellen, who was also a candidate and is now deemed the new front-runner. Obama has also said he was considering former Fed vice chair Donald Kohn to succeed Bernanke, whose second term expires in January.
Traders now give a 55 percent probability of the first rate hike in December 2014, and 68 percent chance in January 2015, according to CME Group's Fed Watch, which generates probabilities based on the price of federal funds futures traded at the Chicago Board of Trade. On Friday, traders saw a better-than-even chance of the first increase in October 2014.
Summers' withdrawal on Sunday came in the face of mounting opposition from within Obama's own Democratic Party. On Monday, U.S. short-term interest rate futures rose as traders shifted away from bets on Summers and toward Yellen, seen as a more dovish policymaker.
"Summers was viewed by the market as someone who would remove accommodation more quickly. He was pretty much priced in," said John Brady, a managing director at Chicago-based RJ O'Brien.
"It's the Fed chairman recalibration trade."
Four Democratic senators on the Senate Banking Committee were expected to vote against Summers if he had been nominated by the president.
The most recent statement of opposition came from Montana Senator Jon Tester on Friday after markets closed. Tester is a centrist Democrat and his opposition provided a strong signal of the uphill climb a Summers' nomination would have faced.
Summers' decision to withdraw from consideration was welcomed on Wall Street, where analysts said it removed the uncertainty a bitter battle over the Fed chairmanship would have caused. Stocks were trading higher. <.N}
Economists said Yellen would provide greater policy continuity with the Bernanke-led Fed, which has been aggressive in its efforts to bring the U.S. unemployment rate down.
The Fed has held the overnight federal funds rate near zero since December 2008, and has more than tripled its balance sheet to around $3.6 trillion, to lift the economy from recession and foster stronger economic growth.
Fed policymakers begin a two-day meeting on Tuesday to discuss the economic and policy outlook, and are widely expected to slow the pace of their bond-buying stimulus from the current rate of $85 billion a month.
While Fed officials have stressed that any cuts to the program would not lead quickly to a rate hike, traders had increasingly bet on an earlier Fed tightening as anticipation for a reduction in the central bank's bond purchases grew.
If Yellen is not nominated, the move "will be perceived negatively by the markets because it leaves the door open longer on who will succeed Bernanke," said Kevin Giddis, head of fixed income capital markets at Raymond James in Memphis, Tennessee. "In the end, she (Yellen) is the best choice."
(Reporting by Ann Saphir in San Francisco and Richard Leong in New York; Editing by Nick Zieminski)