Federal funds futures imply 79% chance of interest rate hike

If the US Fed is focussing on job data only, then the likelihood of a rate hike in the December 15-16 meeting is pretty high.

Federal funds futures contracts imply a 79 per cent chance that the Fed will end seven years of near-zero interest rates at its December meeting. Its key policy rate has been 0-0.25 per cent since the depths of the financial crisis in late 2008, and there are about even odds of a second rate rise by March.

Beyond that the outlook is more mixed. Interest rate futures maturing in the second half of next year are rising slightly, showing traders are wagering the Fed will manage no more than two further hikes before the end of next year.

Within the Fed, there is no consensus and there is an open debate happening on the issue between doves and hawks as to what the pace of increases should look like.

Narayana Kocherlakota, in his latest speech as president of the Minneapolis Fed, gave a sharp critique of a central bank that he said was too anxious to begin raising rates and thus would fail to create perhaps millions of jobs in a timely manner.

James Bullard, the more hawkish head of the St. Louis Fed and FOMC member, followed it up with the argument that it is time to raise rates and begin shrinking the central banks' $4.5 trillion balance sheet, which was bulked up in recent years to boost the economy.

Wall Street's top banks said in a Reuters poll on Friday that they expect the central bank to maintain a slow pace of rate hikes, with the median forecast for the fed funds rate for mid-2016 about 0.75 per cent and 1.125 per cent for the end of the year.

The Fed's policymakers hold very different views of where the central bank's benchmark rate will end next year, ranging from less than zero to 3.0 per cent, according to projections released in September that were based on their views of appropriate policy.

The median outlook was for 1.0 per cent rise next year, while their views of the long-term normal level range from between 3.0 per cent and 4.0 per cent.

Janet Yellen, the Fed Chairperson, has a reputation of being a consensus seeker and has a tough job ahead specifically for the upcoming meeting on not only whether to hike the rates now, but also what should the future pace of rates hikes be.

Predicting the outcome at the moment is similar to tossing a coin, although investors can depend on the probability statistics depicted by Fed fund futures contracts to some degree.

(The author is an investment strategist)