Download Investors Cast Wary Eye on Fed Rate Increases

Investors Cast Wary Eye on Fed Rate
Increases
Broad decline in the dollar and a sharp drop this year
in U.S. Treasury yields mark significant shift in investor
sentiment
ENLARGE
The U.S. dollar posted its biggest declines in months against the euro and yen. Photo:
Andrew Harrer/Bloomberg News
By
Ira Iosebashvili and
Carolyn Cui
Feb. 3, 2016 8:07 p.m. ET
28 COMMENTS
Investors are rethinking their expectations for interest-rate increases this year, converging
on a view that the Federal Reserve is unlikely to raise rates in March and possibly not
even for the rest of the year.
The shift was evident in a broad decline in the dollar on Wednesday and in the sharp drop
this year in U.S. Treasury yields. Futures markets now are predicting there is little chance
that the Fed will raise interest rates at its meeting next month and a less-than-even chance
that it will raise rates this year, a sharp reversal from six weeks ago.
Some analysts have been rolling back their predictions for Fed rate increases, a gauge
closely followed by investors because of its implications for the health of the U.S.
economy. Goldman Sachs Group Inc. economists on Wednesday said that they no longer
think the Fed will raise rates next month, citing soft economic data and tighter financial
conditions as a result of the rise over the past year of the dollar.
The U.S. currency on Wednesday posted its biggest declines in months against the euro
and yen, while also losing ground against the Canadian dollar, Australian dollar, British
pound, and a host of emerging-market currencies such as Russia’s ruble. The WSJ Dollar
Index, which measures the greenback against a basket of 16 currencies, dropped to its
lowest level since late December.
Oil, which has fallen as the dollar strengthened over the past year, shot up 8% in New
York. A stronger dollar typically weakens crude prices by making the dollar-denominated
commodity more expensive in other currencies.
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The selloff in the dollar marked a break in the currency market’s long-held view that the
Federal Reserve will raise interest rates several times this year. Traders had been betting
heavily that the Fed’s inclination to raise rates at a time when central banks in Europe and
Japan are rolling out new measures to stimulate their economies would boost the dollar.
“The market came into 2016 expecting that U.S. rates will go higher while rates in other
countries fall,” said Shahab Jalinoos, an analyst at Credit Suisse Group AG. “Now,
expectations for a rate increase are being aggressively reduced in the currency market,
and that is being priced into the dollar.”
Wednesday’s decline followed weak data from the U.S. service sector and dovish
comments from a Fed official. Some investors now believe that rate increases may come
at a much slower-than-expected clip this year, if at all. The Fed lifted short-term interest
rates by a quarter percentage point in December and penciled in four more increases this
year.
This latest round of data seemed to undermine signs, such as recent U.S. job growth, that
pointed toward a stronger recovery.
After Federal Reserve Bank of New York President William Dudley said recent market
turmoil may alter the U.S. growth outlook, Fed governor Lael Brainard told The Wall
Street Journal in remarks published Wednesday that market volatility and weak
emerging-market growth strengthen the case for going slowly on further interest-rate
increases.
ENLARGE
“Recent developments reinforce the case for watchful waiting,” Ms. Brainard said.
Yields on two-year Treasurys, which are sensitive to expectations of Fed rate moves,
fell Wednesday to their lowest level since October, indicating little confidence the Fed
can raise rates soon.
More broadly, the sharp move in the dollar underscored the central role that the $5 trillion
currency market has played in this year’s volatility. China’s moves to depreciate the yuan
sent markets spiraling downward in January and drove investors into the haven of the
Japanese yen. The Bank of Japan surprised markets last week by adopting negative
interest rates—charging banks to deposit their cash—sending the yen back down. Central
bankers in the U.S. and Europe have expressed concern about the strengthening of the
dollar and euro.
Fed-funds futures, used by investors and traders to place bets on central-bank policy,
showed Wednesday that they expect only a 14% likelihood of a rate increase from the
Fed at its March policy meeting, according to data from CME Group Inc. Late last year,
it was more than 50%. Investors expect only a 40% probability that the Fed will raise
interest rates by next December, the data showed.
Late Wednesday in New York, the dollar bought ¥117.89, giving up all the gains it made
against the Japanese currency on Friday, when the Bank of Japan lowered some interest
rates into negative territory for the first time. The euro was at $1.1104, from $1.0920 late
Tuesday, its highest level since October.
To be sure, investors could pile back into the dollar on indications that the U.S. economy
is on solid ground, such as rising consumer prices or jobs growth. Investors will be
watching Friday’s employment numbers, which many believe offer a reliable snapshot of
the economy’s performance.
Still, many investors are braced for amplified volatility in a world in which the Fed is
acting less as a shock absorber than before it began tightening monetary policy. The
payrolls data could realign expectations about the Fed’s likely moves yet again.
The U.S. currency’s weakness Wednesday was aggravated by the large number of
investors who had been betting on a continued rally in the greenback and moved
quickly to close those positions when the dollar tumbled, traders said.
Net bets on further rises for the dollar stood at $26.3 billion on Jan. 26, according to data
from the Commodity Futures Trading Commission and HSBC Holdings PLC.
The dollar’s selloff was also the latest sign that investors are turning gloomier on U.S.
growth. The strong dollar itself is one of the problems, making U.S. exports less
competitive and lowering the dollar value of overseas sales.
Snacks maker Mondelez International Inc. and Apple Inc. this week warned that dollar
strength hit their quarterly earnings, sending their shares down.
MetLife Inc. reported a 13% decline in operating profit Wednesday, citing in part weaker
foreign currencies that meant overseas sales converted to fewer dollars.
Write to Ira Iosebashvili at [email protected] and Carolyn Cui at
[email protected]