Markets getting ready for a Fed rate hike soon

Markets getting ready for a Fed rate hike soon

As the policy debate heats up at the Fed, investors are getting more acclimated to the idea that a rate hike is coming soon.

The central bank passed on raising its interest rate target at the March meeting, and in doing so indicated that earlier indications of four hikes this year were too aggressive. That forecast came from the December meeting, during which the Fed hiked its rate a quarter point, the first increase in more than nine years.

However, the March decision didn't seem to sit well with some members of the Federal Open Market Committee, the bank's monetary policymaking arm, even though only Kansas City Fed President Esther George dissented. In recent days, at least four member have made statements indicating they're tired of waiting and believe the Fed should get back on the path to normalisation.

Futures markets have been reacting to the hawkish chatter.

The market now assigns a 54 per cent chance to a July hike, a 7 percentage point increase from Tuesday and 21 percentage points higher than a month ago, according to the CME's FedWatch tracker.

While a considerable rise, the market and the Fed still remain somewhat at odds.

In the most recent version of the "dot plot" of committee members' expectations released last week, the current forecast is for two hikes in 2016. However, FedWatch indicates only about a 36 per cent chance of another hike in December and a 41 per cent by the February 2017 meeting.

Fed fund futures monthly contracts, on which the FedWatch indicator is based, also have shifted considerably. The first full rate hike is now priced in for next December; as recently as early February, just as the S&P 500 bottomed, the first hike wasn't priced in until the early part of 2018.

Read More Market's message to the Fed: We don't believe you Following last week's FOMC meeting, Chair Janet Yellen insisted that April is a "live" meeting in terms of a rate hike possibility, even though there is no post-meeting news conference scheduled. However, Yellen has stated in the past that if the FOMC decided to move in an off month, an impromptu news conference could be scheduled.

Of course, the market is fickle in general but especially when it comes to its Fed policy expectations. Should there be another growth scare and financial markets turn volatile, the market's bets could move quickly.

"Just days after Fed officials opted to leave rates unchanged at the March FOMC meeting, Committee members have again began bolstering expectations for a second rate hike in the not so distant future," Lindsey Piegza, chief economist at Stifel Fixed Income, said in a note.

"However, with inflation and labour market conditions improved as of this month's meeting, it was clear international 'risks' were the cause of the delay in further removal of accommodation; if the international market is not improved by summer, will the Fed continue to remain on the sideline even with additional domestic gains?" she added. "In other words, are the latest Fed comments setting the market up for another head fake amid lingering turmoil abroad?"

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