Fed stuck at zero into 2015 seen in swaps, QE odds reach 99%

More Accommodation

“They do stand ready for more policy accommodation and that will likely take the form of an expansion of the balance sheet in longer dated Treasuries or mortgages,” Jeffrey Rosenberg, chief investment strategist for fixed income at BlackRock Inc. in New York, which has $3.5 trillion under management, said in a telephone interview on Sept. 7. He anticipates the Fed will provide more guidance on the timing of rate policy first.

The Fed lowered its target rate for overnight loans between banks in December 2008 to a range of zero to 0.25 percent.

Implied forward rates for contracts that show what traders expect the federal funds effective rate to average over a set time period in the future indicate that a quarter-percentage advance won’t come until about July 2015. Two months ago, the swaps predicted an increase by about March of that year.

Bond Swaptions

Volatility as seen in the debt options market fell this quarter to the lowest levels since before the financial crisis in June 2007, the opposite of what would likely happen if traders expected the Fed to tighten monetary policy soon.

A measure of the perceived degree of future swings in swap rates, known as normalized volatility, for three-month options on 10-year interest-rate swaps, or 3m10y swaptions, touched 71.8 basis points on July 23, before ending last week at 79.7 basis points. A year ago, the reading was above 110.

If the central bank says it will keep rates lower for longer, volatility may fall toward 70, according to Jim Lee, head of U.S. derivative strategy at Royal Bank of Scotland Group Plc’s RBS Securities Inc. in Stamford, Connecticut. RBS, which is also a primary dealer, sees a 90 percent chance that policy makers will announce a new round of debt purchases.

A gauge of indicators of market expectations for additional central bank stimulus rose to a record 99 percent in August, according to Citigroup Inc. The measure increased to 82 percent in the months before QE2 in November 2010.

Reducing Forecasts

Bond strategists and economists have reduced their yield forecasts. The median of more than 70 estimates in a Bloomberg survey published Aug. 9 found that they see 10-year yields ending this year at 1.65 percent and 2.38 percent in 2013. In the prior monthly poll they saw 1.9 percent and 2.7 percent.

Central bank action may be losing some of its punch. Currency trades designed to benefit from expectations of stronger growth as the Fed eases are instead losing money.

The so-called carry trade, where investors borrow in lower- rate currencies such as dollars to buy higher-yielding ones, has fallen 2.8 percent from a four-month high on Aug. 9, the UBS AG V24 Carry Index shows. After Bernanke signaled QE2 in August 2010, the transaction gained 3.1 percent in 30 days.

“The longer the Fed says it’s going to wait to raise rates, the less confident many investors and businesses may be on the outlook,” Joseph LaVorgna, chief U.S. economist for Deutsche Bank Securities Inc. in New York, said in an interview on Sept. 6. “That would send a negative message to people and they want to be less negative.”

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