New York: A majority of Wall Street’s top bond firms see no move by the Federal Reserve to raise interest rates before the second half of next year, and most see the US central bank sticking with a range rather than a specific target for the key fed funds rate, a Reuters survey showed on Friday.
The results are otherwise broadly unchanged from a survey taken in early June.
Twelve of 18 primary dealers, or the banks that deal directly with the Fed, said the US central bank’s first rate increase would occur between July 2015 and June 2016, the survey found.
All but three of the 22 primary dealers participated in the survey.
The view that ultra-loose policy would continue for some time persisted after Friday’s monthly employment report, which showed the US economy added more than 200,000 jobs for a sixth straight month in July - a string of gains not seen since 1997 - and after data earlier in the week showed the economy grew at a faster-than-expected 4 percent annual rate in the second quarter.
Nonfarm payrolls increased 209,000 last month, missing economists’ median expectation of a gain of 233,000, after surging by 298,000 in June.
“It fits into (the Fed’s) view of the world. There’s progress in job growth, but slack is still ample. There was no growth in average hourly earnings,” said Jay Feldman, economist at Credit Suisse in New York.
Concern about wage inflation intensified on Thursday as data showed US labour costs recorded their biggest gain in more than 5-1/2 years in the second quarter. However, Friday’s data showed average hourly earnings rose only one cent last month.
In the survey, 15 of 17 Wall Street firms expected the Fed would stop reinvesting the proceeds from maturing bonds it holds on its $4.4 trillion balance sheet after or around the same time as the first rate increase. That compares with 12 out of 17 who responded that way a month ago.
Fed Seen Setting Range
The most marked difference from June’s survey was that most dealers now expect the Fed to target the funds rate at a range, rather than keeping a specific rate level as it customarily did before the latest financial crisis. A month ago just two of 16 dealers saw the Fed opting for a range.
Since December 2008, the Fed has targeted a range of zero to 0.25 percent for its key funds rate.
In Friday’s survey, nine dealers forecast the Fed would target a range of 0.25-0.50 percent once it begins to raise interest rates. Two more see a range with 0.50 percent as the upper band, with the lower ends at 0.30 percent and 0.35 percent. A sole dealer forecast the range to be between 0.175 percent and 0.375 percent.
Among the five dealers that see a specific target for the fed funds rate, three have it pegged at 0.50 percent and two at 0.25 percent once it begins to rise.
Among 15 primary dealers, the median forecast for the Fed’s long-term neutral target rate, which is seen as a level that promotes growth without firing up inflation, was 3.50 percent.
This was below the current 3.75 percent estimate from the Federal Open Market Committee, the central bank’s policy-setting group.
Analysts bullish
Wall Street’s worst week in two years was enough to get investors worried about whether a long-overdue correction is coming, but analysts are still leaning bullish.
The S&P 500 ended the week down 2.7 percent, its biggest weekly loss since June 2012, a decline that had followed several weeks of selling.
The market is undoubtedly ripe for a correction - the current rally has continued for nearly three years without a decline of more than 10 percent. The Fed looks closer to raising rates, and housing and auto sales figures suggest those markets may be softening, if only temporarily.
“The summer has been just tough because there has been very little to buy,” said Kathleen Gaffney, portfolio manager of the Eaton Vance Bond Fund. “But I think what is happening is we are seeing the markets adjusting from an environment of lower interest rates to higher interest rates – and that’s producing volatility.”
The Federal Reserve’s monetary policy has been favorable for the markets, and though the Fed is expected to begin raising rates next year, the absence of wage pressures has kept moves in Treasuries yields relatively muted.
While the spread between long- and short-dated Treasuries has narrowed of late, which tends to happen as the economy slows, the difference between the two-year and 10-year Treasury notes is more than 2 percentage points - still a favourable sign for economic growth.
On Wednesday, the Federal Reserve gave a rosier assessment of the US economy while reaffirming that it is in no hurry to raise interest rates. The US central bank also, as expected, reduced its monthly asset purchases to $25bn from $35bn.
Although government data on Friday showed US job growth slowed in July and the unemployment rate unexpectedly rose, recent economic data has been largely positive with growth in second-quarter gross domestic product at 4 percent and favorable revisions to first-quarter GDP.
The CBOE Volatility index .VIX, Wall Street’s so-called fear gauge, jumped to 17.03 from 12.69 after Portugal’s Banco Espirito Santo reported an unexpectedly large loss for the first six months of the year that raised concerns about the bank’s solvency and after U.S. employment cost pressures came in higher than anticipated.
But the VIX remains well under the long-term average of about 20, and stock valuations remain reasonable. The S&P 500 .SPX is trading at an average price-to-expected earnings ratio of 15.4, which is not very stretched relative to the historical average of around 14.1.
“The economic environment remains healthy. As such, volatility should decline and stocks should rebound,” said Jonathan Golub, chief US market strategist at RBC Capital Markets.
Even so, the fact that the benchmark S&P 500 hasn’t been able to crack the 2,000 milestone despite a few approaches suggests some exhaustion is setting in.
Agencies
