29 April 2017

Investors Cast Wary Eye on Fed Rate Increases

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Investors are rethinking their expectations for interest-rate increases this year, converging on a view that the Federal Reserve is unlikely to raise rates in March and possibly not even for the rest of the year. The shift was evident in a broad decline in the dollar on Wednesday and in the sharp drop this year in U.S. Treasury yields. Futures markets now are predicting there is little chance that the Fed will raise interest rates at its meeting next month and a less-than-even chance that it will raise rates this year, a sharp reversal from six weeks ago.

Some analysts have been rolling back their predictions for Fed rate increases, a gauge closely followed by investors because of its implications for the health of the U.S. economy. Goldman Sachs Group Inc. economists on Wednesday said that they no longer think the Fed will raise rates next month, citing soft economic data and tighter financial conditions as a result of the rise over the past year of the dollar.

The U.S. currency on Wednesday posted its biggest declines in months against the euro and yen, while also losing ground against the Canadian dollar, Australian dollar, British pound, and a host of emerging-market currencies such as Russia’s ruble. The WSJ Dollar Index, which measures the greenback against a basket of 16 currencies, dropped to its lowest level since late December. Oil, which has fallen as the dollar strengthened over the past year, shot up 8% in New York. A stronger dollar typically weakens crude prices by making the dollar-denominated commodity more expensive in other currencies.

The selloff in the dollar marked a break in the currency market’s long-held view that the Federal Reserve will raise interest rates several times this year. Traders had been betting heavily that the Fed’s inclination to raise rates at a time when central banks in Europe and Japan are rolling out new measures to stimulate their economies would boost the dollar.

Wednesday’s decline followed weak data from the U.S. service sector and dovish comments from a Fed official. Some investors now believe that rate increases may come at a much slower-than-expected clip this year, if at all. The Fed lifted short-term interest rates by a quarter percentage point in December and penciled in four more increases this year. This latest round of data seemed to undermine signs, such as recent U.S. job growth, that pointed toward a stronger recovery.

After Federal Reserve Bank of New York President William Dudley said recent market turmoil may alter the U.S. growth outlook, Fed governor Lael Brainard told The Wall Street Journal in remarks published Wednesday that market volatility and weak emerging-market growth strengthen the case for going slowly on further interest-rate increases.

Yields on two-year Treasurys, which are sensitive to expectations of Fed rate moves, fell Wednesday to their lowest level since October, indicating little confidence the Fed can raise rates soon. More broadly, the sharp move in the dollar underscored the central role that the $5 trillion currency market has played in this year’s volatility. China’s moves to depreciate the yuan sent markets spiraling downward in January and drove investors into the haven of the Japanese yen. The Bank of Japan surprised markets last week by adopting negative interest rates—charging banks to deposit their cash—sending the yen back down. Central bankers in the U.S. and Europe have expressed concern about the strengthening of the dollar and euro.

Fed-funds futures, used by investors and traders to place bets on central-bank policy, showed Wednesday that they expect only a 14% likelihood of a rate increase from the Fed at its March policy meeting, according to data from  CME Group Inc. Late last year, it was more than 50%. Investors expect only a 40% probability that the Fed will raise interest rates by next December, the data showed.

To be sure, investors could pile back into the dollar on indications that the U.S. economy is on solid ground, such as rising consumer prices or jobs growth. Investors will be watching Friday’s employment numbers, which many believe offer a reliable snapshot of the economy’s performance. Still, many investors are braced for amplified volatility in a world in which the Fed is acting less as a shock absorber than before it began tightening monetary policy. The payrolls data could realign expectations about the Fed’s likely moves yet again.

Click here to access the full article on The Wall Street Journal.

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