I only planned to do one post tonight, but this was too good to pass up. Via macroblog comes word that the market might be thinking twice about whether the Fed is done or nearly done raising interest rates.
For better or worse, "measured pace" lives. Check it out. The implied probability of another 50 basis points by October is almost at 60%. This after being in the 30-40% range since late April.
The rather sudden turn in the implied probabilities is not all that puzzling. Clearly last week provided the market with new information. After mulling it over the long weekend, traders are putting that new information into practice.
So is the economy really doing better than market participants were expecting? Maybe. I mean, the bond market is not infallible. For my money, they have been too pessimistic so far this year. But even some Fed watchers are a little surprised. I admit to being less surprised.
In the final analysis, I think what we're seeing here is the market adjusting to information. The Fed has been cryptic about when the rate hikes would stop. That heightened speculation that they would stop soon. The Fed essentially said, "Think again." This isn't a sign that things are going wrong. While it's not a perfectly transparent process, information gets transmitted and the market reacts. What we are seeing is what we teach in our classes.
In a comment over at Mark Thoma's blog, I had one of my better predictions concerning what I thought the committee might say in the statement after the meeting. I missed one thing though, and I think it is important. The Fed (and I think the market too) believes that the increase in energy prices is not likely to translate into long term inflation problems. From the statement:
Although energy prices have risen further, the expansion remains firm and labor market conditions continue to improve gradually. Pressures on inflation have stayed elevated, but longer-term inflation expectations remain well contained.
And in turn, long term expectations are keeping the 10 year yield well contained. Inflation expectations matter, and I haven't seen any indication that the news that the market is responding to has much to do with long term inflation expectations. There hasn't been as much talk about this, but it's a very important point.
I actually see the movement in the fed funds futures and the 10 year in the last few days as an understandable, if not totally expected, move. Just a real-time adjustment in short-term (3-12 month) expectations--not a lot more. I'll just say that for now anyway, any attempt to make this into a lot more is probably much ado about nothing.
I do, however, think that the minutes to the meeting just ended will be worth reading indeed. And I'll report on them here.
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