A March interest-rate increase by the Federal Reserve, an unlikely scenario just days ago, is now suddenly on the table after an unexpectedly strong inflation print and hawkish testimony from Fed Chair Janet Yellen to Congress.
Traders’ expectations for a hike next month jumped after consumer prices rose the most in January since 2013. Derivatives traders are pricing in a 42 percent probability that the Fed raises rates at its March 14-15 meeting, up from 24 percent on Feb. 6. That’s based on the assumption that the effective fed funds rate will trade at the middle of the new FOMC target range after the next increase. The uptick in March odds also comes after Yellen reiterated in semi-annual testimony to the House and Senate Tuesday and Wednesday that waiting too long to tighten policy “would be unwise.”
While traders are still pricing in only two rate hikes for 2017, expectations are starting to catch up to the Fed’s projections for three increases this year, a swing in market sentiment that risks driving Treasury yields even higher. The shift stands in contrast to the past two years, when the Fed tightened less than forecast.
“The acceleration in the inflation picture along with the continued strong performance of the consumer sector opens the door and increases the probability that the Fed will raise rates as soon as March,” said Ward McCarthy, chief financial economist for Jefferies LLC in New York.
Benchmark two-year Treasury yields reached the highest since late December after Labor Department data showed the consumer-price index rose 0.6 percent in January, the most since February 2013. Compared with the same month last year, costs paid by Americans for goods and services rose 2.5 percent, the most since March 2012.
The difference between yields on five-year notes and Treasury Inflation Protected Securities, a gauge of trader expectations for consumer prices during the life of the debt known as the breakeven rate, rose the most since Dec. 22, to 2.01 percentage points.
While March may be too early for the Fed to raise rates, it’s a good opportunity for the central bank to prepare markets for a move in May, Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. in New York, wrote in a report Wednesday, bringing forward his call from June.
The odds of a Fed rate increase in March have risen to 30 percent from 20 percent previously, Goldman Sachs Group Inc. economists led by Jan Hatzius wrote Wednesday.
“Even though data makes a pretty strong argument for a Fed rate hike and people are starting to buy into it, they’re not jumping in with both feet,” said Todd Colvin, senior vice president at futures and options broker Ambrosino Brothers in Chicago.
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