Friday, January 27, 2012

The Fed extended start of tightening by 3 months, not 18

It looks like some in the media are now using the appropriate language with respect to the Fed's latest action. Reuters, who tends to be fairly accurate in their reporting, described the extended low rate environment as being "probable" instead of "certain".
Reuters: The statement by the Fed, which announced on Wednesday it would probably keep interest rates near zero until at least late 2014 - some 18 months later than the Fed had suggested last year.
Given that we are working with probabilities instead of certainties, how did this event change the the timing of expected rate hikes?  After all the general perception (as per Reuters quote above) is that the rate hike has been extended by 18 months.

The best markets to provide visibility into the Fed's future policy are the Chicago Board of Trade Fed Funds Futures contracts. The chart below compares the implied Fed Funds rates prior to the Fed's announcement as well as now.

Fed Funds rate implied by the Chicago Board of Trade Fed Funds Futures (Bloomberg)

The curve has definitely shifted further out, but not by 18 months as is generally believed. The shift is actually only about three months.  The current curve is implying the first rate hike to be in the early part of 2014. So for those who are planning on zero rates throughout 2014 and into 2015, pay attention to the market - it may tell you otherwise.
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