The subject of interest rates and when the Federal Reserve may raise rates again has been the object of much speculation since the Fed hiked rates last December (2015) for the first time in nearly a decade.
Now that the initial move towards normalizing monetary policy has taken place, investors are left wondering when the central bank could hike rates again. The reality appears to be that the next hike is much further off than markets had expected just several months ago. In fact, the next hike may not take place until January 31st, 2018.
Why not until then? The reasons are numerous, but money market derivatives are pointing to no more than a 50 percent chance of a hike until then. Not only do the chances of another hike before then seem extremely unlikely, but the central bank may be more likely to cut rates again before raising them.
This outlook is a far cry from the four rate hikes that were anticipated to take place in 2016. While things were looking more positive for some time, the wheels then fell off the bus.
The recent Brexit referendum, in which the people of Great Britain voted to leave the European Union, could represent a major hurdle for global financial markets. Following this historic vote, equity and commodity prices plunged while the the dollar saw heavy buying and interest rates declined. The Brexit vote has driven down inflation expectations while also causing further concerns over the global economy.
While there may be ongoing talk of additional rate hikes by the Fed, it is difficult to imagine the Fed being aggressive with further rate hikes as the cloud of uncertainty hangs over global markets and the era of negative interest rates appears ready to spread further.
While Fed Funds futures are pricing in a small chance of another rate hike prior to 2018, any talk of further hikes may be more about maintaining credibility for the central bank. In fact, some believe the central bank could move to cut rates again if economic conditions don’t exhibit significant improvement soon.
While interest rate expectations can and do change quickly based on economic data and other factors, Fed Funds futures currently point to some time before the next hike is seen. Implied yields on these futures contracts are now pricing in a real possibility of a rate cut by the end of the year. In recent weeks, the implied rate stood at .41 percent, and is foreseen by traders averaging .37 percent by December.
The bottom line is that following Brexit, weakness in China and other global economic issues, monetary policies are likely to be supportive of economic growth.
1988 all over again?
Back in 1988, Federal Reserve head Alan Greenspan began cutting key interest rates in September, before resuming rate hikes in June. The current situation has the potential to closely resemble what occurred then. While the central bank could move to cut rates to zero again, once the shock and awe of such a move is over it could look to begin the normalization process again.
With treasury yields currently near all-time lows, the Fed may simply hold the course for the time being, keeping a rate cut in its back pocket should conditions see a significant downturn. In all likeliness, however, the Fed is likely to sit by and do nothing for the time being.
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