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UPDATE 3-Traders best Fed in U.S. rate-hike expectations
March 16, 2016 / 7:04 PM / in 2 years

UPDATE 3-Traders best Fed in U.S. rate-hike expectations

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By Ann Saphir and Richard Leong

March 16 (Reuters) - In the tug of war for influence over financial markets, bond traders appear to have won another round after U.S. Federal Reserve officials cut their estimates on the number of times the central bank would likely raise interest rates through 2018.

The Fed kept rates unchanged on Wednesday, confirming traders’ outlook for a very modest increase in the federal funds rate this year.

Policymakers remain more optimistic about the economy than traders, analysts said. But the Fed’s latest U.S. rate projection implies only two quarter-point increases in 2016, half the number it suggested in December.

“The market has questioned all along whether they could hike four times year. The Fed acknowledged they were right,” said Michael Arone, chief investment strategist at State Street Global Advisors in Boston.

The Fed and futures market still diverge in their outlook for the fed funds rate, called the “dot plot” because each Fed governor’s prediction is plotted on a chart. However, the discrepancy was much larger in December 2014 when Fed officials on average forecast four more hikes than what traders expected.

Many traders have said that U.S. economic data have not been strong enough to support more than a couple of interest rate increases at most this year, citing a slump in exports and the energy sector.

Policies in Europe and Japan to keep rates below zero have also made it tougher for the Fed to raise U.S. rates much higher, analysts said.

“The Fed is being cautious here; they’re highlighting international risks as key risks,” said Edward Al-Hussany, senior currency and rates analyst at Columbia Threadneedle in Minneapolis.

Traders quickly pared expectations for a June rate hike after the Fed said moderate U.S. economic growth and “strong job gains” would allow it to raise rates gradually this year, though more slowly than it had earlier expected.

But traders kept their view that the Fed was likely to raise rates just once this year, as early as July but more likely in September.

Before the report they were pricing in about even odds for a June rate hike, with the odds rising to more than 80 percent by December, and little chance of a second rate hike by then.

Traders now see about a 54 percent chance of a rate hike in September, based on futures contracts traded at CME Group Inc, down from 70 percent before the Fed ended its two-day policy-setting meeting.

Chances of a December rate hike declined to 69 percent.

Fed officials are likely to walk a tightrope in coming months as investors speculate on the timing of a rate hike, analysts said. The Fed raised rates for the first time in nearly a decade in December.

The Fed could turn more hawkish again if U.S. inflation and employment data stay stronger than expected in coming months, analysts said.

“Policy is not on a preset course,” Fed Chair Janet Yellen said at her news conference on Wednesday.

Additional reporting by Saqib Ahmed, Sam Forgione in New York; Editing by Chizu Nomiyama and Richard Chang

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