Saturday, March 07, 2015

Fed rate outlook for 2015 - up to 66% chance of Liftoff in September, up to %54 chance of second hike in October, up to 60% chance of third hike in January

The main message from this past week was that while the economy is a little stronger than previous thought, especially despite the harsh winter and storms, September is still on track for liftoff, and the fed funds rate is still most likely to be at 0.75% at the end of the year. IOW, no big change that would affect the stock market - despite the chatter to the contrary.

The Fed Beige Book indicates that the economy is in reasonable enough shape that the patient language is no longer urgently needed, and more than a few Fed officials would prefer to have the flexibility to to at least have June on the table for liftoff, even if they still feel June is still likely to be too soon for liftoff.

The strong jobs report on Friday was merely icing on the cake of the Beige Book and did not change the overall picture substantially.

It's a coin flip whether the FOMC will indeed remove the patient language after their meeting on March 18th, the week after next. I wouldn't be surprised either way, whether they remove it this month or next month at their April meeting. At this stage I lean a little more towards this month since it's almost a no-brainer since it merely gives them flexibility in June without committing them to a June liftoff per se. It may simply come down to whether we get any dramatically serious negative economic news over the next 10 days; if not, then the patience language will likely go. And if we get some strong economic news, especially on the retail sales front, it will be a slam dunk to remove the patience language.

Also note that the price of oil has stopped falling and even recovered somewhat, which will restore some amount of pressure on consumer prices. But... the full impact of the bulk of the dramatic decline of the price of oil and derivative products has not yet been fully transmitted throughout the entire economy, including iterative feedback loops, so oil is probably a net reduction of inflation directly, but a net increase for economic activity, which in turn is an incremental increase in inflationary pressure. How that all nets out for both inflation and economic activity is very uncertain and will be quite dynamic over the rest of the year. I think it will be a wash, but since the economy is only growing at a moderate pace and with only modest inflation, none of this should cause the Fed to change course significantly from its current trajectory - a very gradual rise in rates beginning in the September time frame.

I'm updating my outlook for Fed rate hikes in 2015 to put a 66% chance (up from 55% a week ago) of liftoff (hike from the current 0.0% to 0.25% range to 0.50%) in September, a 54% chance of a second hike in October (vs. 39% a week ago), only a 38% chance of a third hike in December, and a 66% chance of a third hike (to 1.00%) in January.

IOW, the fed funds target rate will be only 0.75% at the end of the year, which is a rate that is still very supportive of stocks and the stock market.

Clearly some people are betting on liftoff in July, but that may be more of a hedge rather than an outright bet. Ditto for June.

My forecast is based on the fed funds futures probabilities provided by the CME Group FedWatch web page:

These numbers are based on fed funds futures contract prices, so they are what actual market participants are betting, not the mere whim of some economist or pundit - or even the Federal Reserve itself.

Incidentally, the CME Group odds for liftoff in July are now 45% (up from 36% a week ago), and 22% in June (up from 17% a week ago.)

-- Jack Krupansky


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