There is uncommon dissent in the ranks of the Federal Reserve’s primary dealers over the US central bank’s interest-rate decision this week.
Two of the Fed’s 23 preferred bond-trading partners — Barclays and BNP Paribas — are betting against their peers and the bond market by forecasting officials will raise rates at the Fed’s latest policy meeting, which starts today.
It is the first time more than one dealer has gone against the consensus during the week of a policy meeting since last September. Economists at both banks say traders have too steeply discounted officials’ intent to hike after the Fed has remained on hold for longer than expected.
“There is no perfect time — there will always be some uncertainties in the data,” said Laura Rosner, senior US economist in New York at BNP. “Despite a multitude of shocks through the last nine months, which have delayed the Fed, hiring has continued to be robust.
“There is a window of opportunity for the Fed to continue normalising, and we think it’ll take it.”
The bond market and Fed are locked in a battle of wills over the direction of interest rates more than seven years after the end of the recession.
The central bank’s credibility is at stake after policy makers began the year projecting four rate increases, after liftoff from near zero in December, yet remained on hold time and again because of economic circumstances in the US and abroad.
Even last month, Fed Chair Janet Yellen and vice chairman Stanley Fischer hinted that the bank could still raise rates twice this year.
The bond market is not buying it. Futures traders are pricing in just a 20% likelihood the Fed will lift its policy rate by 0.25 percentage point at its meeting today and tomorrow, based on the assumption that the effective fed funds rate will trade at the middle of the new Federal Open Market Committee target range after the next increase.
That is down from more than 40% in late August.
The yield on the Treasury two-year note, the coupon security most sensitive to Fed policy expectations, was 0.78% early yesterday.
That is barely above the 0.75% federal funds rate upper bound implied by the hike that Barclays and BNP forecast this week. The two-year yield began the year at 1.05%. The benchmark 10-year note yielded 1.69% yesterday.
Traders lowered the odds of a hike after US employers added fewer jobs than forecast in August and service industry expansion slowed.
For Barclays and BNP, those single data points belie broader labour-market strength, as shown by the largest three-month increase in non-farm payrolls since January.
BNP wrote off any chance of a 2016 hike in February, when signs of slowing economic growth triggered volatility across global financial markets.
Once the dust settled on Brexit in July, as stocks rallied and payrolls data rebounded, the bank saw September as the Fed’s best chance to resume tightening monetary policy, Ms Rosner said.
Barclays had forecast a rate hike at the Fed’s June meeting until a dismal May jobs report at the beginning of that month.
“We’re not the crazy house — this is the first time we’ve been so far out of consensus on the view,” said Barclays senior US economist Rob Martin.
“We’ve kept our conviction on September because we think that’s what the FOMC has communicated to us.”
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