A few weeks ago I noted that the fed funds futures contracts seemed to reflect an expectation that we’d see one more rate hike this fall, and that would be it. But a lot can change in two weeks. Now the message looks more like, “that’s it!”
As of July 13, a contract whose payoff depended on the average fed funds rate during November was trading at an implied rate of 5.46%, suggesting one more bump from the current 5.25% target at one of the next three FOMC meetings. That November contract has since drifted down to 5.37%, meaning it’s even money whether there will be even a single hike at any of the next three meetings, and relatively unlikely that, if another hike is selected, it would come as quickly as the August 8 meeting.
Macroblog notes a similar conclusion from options prices, which suggest that traders now see only a 30% chance of a hike at either the August or September meeting. And Bloomberg today notes statements by FOMC Member Janet Yellen and FOMC Alternate Member William Poole suggesting they might be comfortable leaving the funds rate where it is for now.
|Measure||Past 6 months||Past year|
|CPI less food-energy||3.2%||2.7%|
So what’s changed? Not good news about inflation, surely. Recall Fed Chair Bernanke’s remarks from less than two months ago:
While monthly inflation data are volatile, core inflation measured over the past three to six months has reached a level that, if sustained, would be at or above the upper end of the range that many economists, including myself, would consider consistent with price stability and the promotion of maximum long-run growth. For example, at annual rates, core inflation as measured by the consumer price index excluding food and energy prices was 3.2 percent over the past three months and 2.8 percent over the past six months. For core inflation based on the price index for personal consumption expenditures, the corresponding three-month and six-month figures are 3.0 percent and 2.3 percent. These are unwelcome developments.
There is basically no way to slice the inflation data since then to come up with numbers that are any lower than these “unwelcome” numerical guidelines that Bernanke identified.
The data arguing for a pause come instead from the real side. In particular, the new home sales figures released Thursday paint a pretty clear picture that the housing slowdown we’d all worried about is now well underway. Falling residential construction made a negative contribution to second quarter GDP and has considerably more downside potential. Some of my ongoing research suggests that what the Fed has already done won’t have its biggest negative effect on new home sales until December. Regardless of what the Fed does now, the housing slowdown is likely to become more dramatic this fall, a theme echoed by Nouriel Roubini and Mark Thoma.
The risks for real output of another immediate rate hike are all too obvious. What about the risks to inflationary expectations if there is a pause? The response in markets such as gold and the dollar was pretty dramatic the last time the pause balloon was floated. However, I continue to believe that a decline in the level of real economic activity is fundamentally a very bearish development for commodity markets, and that longer term, Bernanke means what he says about not allowing 3% inflation to persist. If speculators bet against either of those propositions, they could end up losing big.
But then again, we won’t know for sure until after it’s all played out, will we?