The Federal Reserve is expected to follow this week’s first post-crisis rate rise by lifting US borrowing costs again in March, according to a Financial Times survey of leading economists.
More than two-thirds of the 42 top economists polled by the FT expect another 25 basis point increase in the central bank’s benchmark rate in three months, taking the Fed at its word even as most investors bet that the pace of future increases will be more gradual.
This contrast with market expectations means Fed chair Janet Yellen faces a fresh set of challenges next year, even though investors this week credited her with having pulled off a long-debated rate move smoothly, without the market tantrums many feared.
Traders and investors now expect the federal funds rate to remain below 1 per cent into 2017. That implies a far shallower pace of increases than the median of the “dots” — the individual projections of Fed policymakers — which point to the federal funds rate reaching 1.375 per cent by the end of 2016 and 2.375 per cent in 2017.
Economists surveyed by the FT aligned more closely with the Fed, with slightly more than half of them expecting the central bank to follow with its third rise by June, to take the funds rate to 0.75-1 per cent.
The Fed’s meeting landed in a volatile week for global equity and credit markets, with US mutual funds and exchange traded funds invested in high-grade corporate debt hit by a record wave of redemptions.
Yields on both Merrill Lynch US investment grade and junk bond indices hit their highest level since 2012 this week, energy prices fell and the trade-weighted dollar logged its greatest weekly gain since the start of November — complicating the picture for Ms Yellen.
Economists have cautioned that lacklustre global economic conditions could stay the Fed’s hand as the dollar depresses exports and sliding oil prices weigh on inflation, a point policymakers have emphasised they will watch.
“It’s critical: everything flows into financial conditions. The trade weighted dollar impacts conditions. Credit spreads play into financial conditions. Equities play into financial conditions,” Ellen Zentner, Morgan Stanley’s chief US economist, said. “To the extent the dollar rises further — depressing inflation in the coming months — will play into how they feel about raising rates.”
Risk markets, which rallied on Wednesday as the Fed confirmed it would tighten policy at a “gradual” pace, have since retreated, with the S&P 500 slipping back into negative territory for the year.
“Defining ‘gradual’ and divining how the Federal Open Market Committee will implement a gradual rate increase will become the new parlour game for financial markets and monetary policy wonks,” said William Lee, an economist with Citi.
Further tweaks to policy from the Bank of Japan on Friday and European Central Bank president Mario Draghi’s insistence earlier this week that the potential remained for further stimulus have not been enough to stem selling in equity markets.
Major global bourse have declined since the month’s start — including roughly 7 per cent falls in German and French indices.
The recent step down in energy prices has unnerved some US portfolio managers, with several concerned about the effect distressed fund closures will have on investor behaviour and subsequent flows.
Economists surveyed by the FT said that the risk remained that the Fed would raise rates two or three times next year, below its current forecast. Only two said the Fed would increase rates just once in 2016.
“Yellen sowed the seeds of a potential pause later on by tying further rate increases to the trajectory in core inflation and also to financial-market developments,” said Thomas Costerg, an economist with Standard Chartered, who expects the Fed will have to cut rates by the end of next year.
“On both fronts, [the] risks are [that] things don’t go according to the Fed’s plans . . . and therefore the Fed hiking cycle may eventually be very short and shallow.”