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Fed's latest rate forecasts still deemed high by traders

Friday, September 18, 2015 - 21:13

[NEW YORK] Federal Reserve officials are once again coming around to the bond market's view that interest rates will stay lower for longer.

The central bank held its benchmark rate near zero Thursday, showing policy makers think inflation still has a way to go to reach their 2 per cent targetĀ amid an uncertain outlook for global economic growth.

For every quarter in 2015 Fed officials lowered projections for the funds rate in coming years. Yet their forecasts are still more aggressive than the path expected by most traders. While the median projection from Fed officials signals a rate increase by year-end, fed fund futures show traders anticipate the central bank may wait until 2016.

"The markets never really bought the Fed story to begin with," said Michael Arone, the Boston-based chief investment strategist at State Street Global Advisors' US Intermediary Business. The firm oversees US$2.4 trillion.

"The markets have been consistently below the dot plot in the rate expectations, and now the Fed seems to be coming a little bit more into the market reality from that standpoint."

Officials cut their median estimate for the fed funds rate at the end of 2016 to 1.4 per cent, from the June forecast of 1.6 per cent. A year later the median of officials' forecasts rises to 2.6 per cent, down from the June projection of 2.9 per cent. The central bank lowered its long-run rate to 3.5 per cent from 3.8 per cent.

Money-market derivatives indicate the fed funds effective rate will average 0.56 per cent in a year, 1.10 per cent in two years and 1.54 per cent in three years. The Fed has held its target for the rate in a range of zero to 0.25 per cent since December 2008.

"The Fed has consistently projected rates as moving higher than what the market does," said Scott Minerd, who oversees US$240 billion as global chief investment officer at New York-based Guggenheim Partners LLC. "So far, the market has been right."

Slowing economic growth in China, the world's second- biggest economy, has rippled across the globe. The MSCI Emerging Markets Index, which includes nations such as Brazil and China, is down about 11 per cent this year.

Futures traders are pricing in about an 18 per cent probability the central bank increases it target range in October, a 44 per cent chance by the December meeting and a 53 per cent likelihood by January. The calculation is based on the assumption that the effective fed funds rate will average 0.375 per cent after the first increase, near the mid-point of the range. Fed funds futures signal the rate moving to 0.22 per cent by year-end.

"Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term," the Federal Open Market Committee said in a statement in Washington.

At their June meeting, Fed officials cut their median forecast for the funds rate for the end of 2016 to 1.625 per cent from 1.875 per cent. At the time, the level implied by futures contracts maturing at the end of next year fell to 1.1 per cent from 1.5 per cent.

BLOOMBERG