Fitch chief economist sees U.S. interest rates at 3.5 percent by 2020

FILE PHOTO - A police officer keeps watch in front of the U.S. Federal Reserve in Washington, DC, U.S. on October 12, 2016. REUTERS/Kevin Lamarque/File Photo

(Reuters) - Investors’ expectations for future U.S. interest rates are too low and could become a source of volatility in bond markets, the chief economist for Fitch Ratings said on Tuesday.

While Fed funds futures prices show investors are anticipating U.S. interest rates will stay low for the foreseeable future, Brian Coulton, Fitch’s chief economist, is expecting the Federal Reserve to raise rates to 3.5 percent by 2020.

“I think there is maybe too much confidence that the Fed is not really going to do too much more on interest rates, that we’ll have one or two more rate hikes and that’s it,” Coulton told Reuters on the sidelines of Fitch’s Global Sovereign Conference in New York, adding that the expectation was “more of a personal view.”

Market participants are expecting “just one or two interest rate increases a year” from the Federal Reserve, he said, in spite of the Fed’s stated expectation of seeing long-run interest rates at 3.0 percent.

“When the Fed says they’re going to engage in a gradual rate of interest rate increases, they mean three or four rate hikes every year and we think that’s what they’re going to do,” Coulton said. “We think that you should take them at their word and it may even be a little faster than that.”

The market’s expectations could create volatility in fixed-income markets, Coulton said.

Fed fund futures prices show that investors expect just one more rate hike as likely by August 2018. The Fed raised rates in December 2015 for the first time in a decade and has raised rates three times since to a range of 1.00 - 1.25 percent. However the U.S. central bank had forecast four rate increases for 2016 and three for 2017, which would have put overnight interest rates at a range of 1.75 - 2.00 percent.

Coulton said he expects the Fed to pick up the pace of rate hikes even if U.S. inflation remains low.

“We think they’re going to be ... getting more worried about some of the negative consequences of (quantitative easing), the fact that it encourages risk taking and may create some issues for the banks,” he said.

Reporting by Dion Rabouin; Editing by Phil Berlowitz