FED’S ROSENGREN: These 5 charts show how the market is wrong about interest rates

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Eric S. Rosengren
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Thomson Reuters

Boston Fed president Eric Rosengren thinks the market is too downbeat about interest rates.

Specifically, Rosengren called out the fed fund futures market, which bets on interest-rate changes, in a speech on Monday about economic and cybersecurity risks.

The gulf between the Fed’s and market’s expectations on short-term interest rates has widened considerably as the Fed has tried to ease monetary policy.

Here’s Rosengren:

My own sense is that financial markets may have reacted too strongly. My assessment is that the U.S. economy is continuing to improve despite the headwinds from abroad. If my forecast is right, it may imply more increases in short-term interest rates than are currently priced into futures markets – but, let me emphasize that my outlook still calls for a gradual pace of increases and, as always, the path should depend on incoming economic data.

Rosengren is a voting member of the Fed’s policy-setting committee.

Here are some charts from his presentation that explain his thinking:


The market has a weaker outlook for the economy than needed

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Boston Fed

This chart shows that the Fed funds futures market is pricing in one 25-basis-point increase each in the federal funds rate by the end of 2016 and 2017.

“This extremely gradual path for reducing monetary policy accommodation would imply either a weak outlook for the economy or significant concerns that even if the expected outlook was benign, there were significant “tail” risks,” he said.


The fed funds market is now more in line with the Fed on rate hikes

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Boston Fed

This chart shows the percentage probability that the fed funds market is attaching to the number of rate hikes this year.

Last week, Fed chair Janet Yellen reiterated that the FOMC intends to raise rates with caution, as it monitors the impact that foreign economic troubles could have on the US economy. Yellen said the Fed would be in a better position to raise rates too quickly than to loosen monetary policy rapidly if it had to.


But expectations are not fixed

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Boston Fed

They have shifted in the past two months based on economic data.


There’s less ‘fear’ out there

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Boston Fed

Expectations are also driven by market volatility, and how the Fed is likely to respond. Rosengren noted that volatility, measured by the Chicago Board of Options Exchange’s index called the VIX, has calmed in recent months.

“With financial market volatility subsiding since earlier this year, it is to me surprising that the expected path of monetary policy embedded in futures markets is so low,” he said.


And the drop in stocks was “modest”

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Boston Fed

Stocks have now rebounded to mid-December levels.


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Lucas Jackson/Reuters

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