Go ahead, Federal Reserve, keep trying to prepare markets for an interest-rate increase this year.
It isn't working.
The longer U.S. central bankers wait to initiate their tightening cycle, the more traders push back their expectations for when borrowing costs will start rising. On Thursday, futures contracts were implying that traders saw the Fed funds rate at about 0.3 per cent by December. That's the lowest estimate of the year, and about half the forecast for the overnight lending benchmark that the Fed gave in March.
The market is essentially calling the Fed's bluff. Traders are betting that policy makers won't be able to raise rates this year without disrupting stocks and bonds, something that they'd really rather not do. So either U.S. policy makers will have to risk another market-wide tantrum, or they'll give in to traders who embrace the idea of these historically low borrowing costs sticking around for longer.
"In the end, the Fed is more likely to 'cave' to the market as opposed to 'fight it' by hiking when the market does not have it priced in," Jim Bianco, president of Bianco Research LLC, said. The Fed still sees low rates "as beneficial and does not want to undermine all the work they have done over the past several years."
In the meantime, Fed members are amping up their rhetoric that yes, a rate hike is coming, yes, it'll probably be this year, and no, it may not be an easy ride for markets. Liftoff "feels most probable somewhere in the late summer than the early summer, but early summer is not out of the question," David Altig, research head at the Federal Reserve Bank of Atlanta, said in Madrid on Wednesday.
A day earlier, the New York Fed's William Dudley had some starker words for traders: when central bankers make their move, they'll usher in a "regime shift" that will stir markets. Mr. Dudley, who is vice-chairman of the policy-setting Federal Open Market Committee, said the timing of a hike is uncertain.
While the U.S. economy is showing signs of recovery after more than six years of unprecedented Fed stimulus, some of the economic data keeps disappointing. One of the latest examples is retail sales that barely budged in April, confounding analyst projections for a small increase.
As the unemployment rate has fallen to 5.4 per cent from as high as 10 per cent in 2009, workers still aren't earning materially bigger paycheques or returning to their erstwhile spendthrift ways.
While the global bond market has lost hundreds of billions of dollars in May, short-term debt yields haven't changed much – another sign investors don't expect the Fed to end the stimulus party any time soon. Yields on two-year Treasuries have fallen to 0.55 per cent from 0.57 per cent on April 30.
Fed members can keep warning traders of shocks that are soon to come, but a lot of folks just aren't buying it.