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How To Interpret Something From Nothing

February 21, 2017


Federal Reserve Chair Janet Yellen garnered a lot of attention this week for her Humphrey-Hawkings testimony before Congress. It appears Fed watchers and financial-market participants were bowled over by the following commentary: Yellen said that if employment and inflation are “continuing to evolve in line with [the FOMC committee’s] expectations” that “a further adjustment of the federal funds rate would likely be appropriate.”

Soon after Yellen’s utterance of these seemingly noncommittal and innocuous words, the odds of an impending Fed hike in the federal funds rate spiked higher. One notable Goldman Sachs economist even ventured to opine that Yellen’s words offer “relatively strong support for near-term policy action.” Near term means that Fed officials could raise the fed funds rate at its next meeting in March.  

Goldman’s economists might be jumping the gun. The odds for a March rate increase did spike, but the odds still favor inaction. Traders in federal funds rate futures contracts are betting only a 22% chance the fed funds rate will be raised next month (though this is five percentage points higher than the odds given last week). The odds don’t rise to 50% that an increase will occur until May. The week before, June was the closest month giving 50% odds.  

It’s unlikely the Fed will raise the fed funds rate next month.  As for May, we’ll believe it when we see it.  We still think June is the closest month for a rate increase to occur (and when it does occur, it will be only 25 basis points). 

So, where does this leave us?  

We still think three rate increases, which were proffered by many prognosticators at the beginning of the year, is too optimistic. Indeed, CNBC noted last week that JPMorgan’s economists now see no more than two rate increases this year. We surmised last month that only one increase could be in the cards. (But if we see two, we won’t be surprised.)  

At this point, market participants just seem antsy for an interest-rate increase, and for interest rates to move higher. This sentiment should settle down once Yellen’s recent testimony is forgotten. But with the strong jobs report for January and consumer price inflation inching higher, we don’t see interest rates easing in the near future.

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