Tag Archives: Interest Rate

Fed officials turn focus to rate debate, eye on jobs, inflation

By Howard Schneider and Ann Saphir

WASHINGTON (Reuters) -U.S. Federal Reserve officials on Monday turned their focus towards a debate over interest rate policy that is likely to intensify in coming months, with one top official saying the conditions for a rate hike could be met next year with job growth expected to continue and inflation already pushing beyond comfortable levels.

Fed Vice Chair Richard Clarida said that while the Fed remains “a ways away from considering raising interest rates,” if his current outlook for the economy proves correct then the “necessary conditions for raising the target range for the federal funds rate will have been met by year-end 2022.”

His remarks come as the Fed shifts attention towards a possible clash between its hope to drive jobs as high as possible, and its concern that inflation is already running too fast.

Inflation to date already presents “much more than a ‘moderate’ overshoot of our 2% longer-run inflation objective, and I would not consider a repeat performance next year a policy success,” Clarida said.

He said economic growth should drive the unemployment rate to 3.8% by the end of next year, and “eliminate the 4.2 million ’employment gap’ relative to” the months before the pandemic.

At that point an interest rate path similar to the one laid out by Fed officials in September would “be entirely consistent” with the Fed’s new framework for hitting its 2% inflation target and reaching “maximum employment,” Clarida said in remarks prepared for presentation at the Brookings Institution.

That rate “dot plot” showed 18 Fed officials evenly split over the need to raise rates next year, with a majority showing rates rising more steadily in 2023 and 2024.

In separate remarks St. Louis Federal Reserve bank president James Bullard repeated his outlook that the Fed will need to raise rates twice next year — with U.S. job markets already so tight it is adding to inflation through growing wage and compensation costs.

“We are going to see downward pressure on the unemployment rate and we are going to continue to see a very hot jobs market with compensation rising,” Bullard said on Fox Business Network. “We’ve got quite a bit of inflation here…we definitely want to see that come down closer to our inflation target.”

“If inflation is more persistent than we are saying right now, then I think we may have to take a little sooner action in order to keep inflation under control,” Bullard .

Two other Federal Reserve bank presidents are due to speak later in the day.

(Reporting by Howard Schneider and Ann Saphir; Editing by Mark Potter and Andrea Ricci)

Analysis – A fine mess: Weak inflation prompts a global central bank reset

By Howard Schneider and Leika Kihara

WASHINGTON (Reuters) – It is an article of faith among central bankers that the decisions they make about how much money to create and what interest rate to charge for it will determine the rate of inflation – at least over moderate lengths of time.

For more than a decade that belief has been undermined by inflation that has remained weak despite trillions of dollars pumped into the world’s biggest economies through quantitative easing programs and ultra-low interest rates.

That prompted the top central banks to review how they do business, and on Thursday the European Central Bank joined the Federal Reserve and the Bank of Japan in pursuing an ambitious reset in hopes of reasserting control.

The ECB’s new framework, in contemplating the occasional “transitory period” when inflation exceeds its formal 2% target in hopes of ensuring that target is met over time, is a step short of the more explicit promise the U.S. central bank made last year to encourage periods of high inflation to offset years when price increases were too weak.

But their shared diagnosis paints a similarly troubling picture of a developed world seemingly set in a rut of slow economic growth, low productivity, aging populations, and perennially weak inflation that may be difficult to coax higher.

“The euro area economy and the global economy have been undergoing profound structural changes,” the ECB said in announcing its new framework, echoing language used by Fed officials in announcing their new strategy last year. “Declining trend growth, which can be linked to slower productivity growth and demographic factors, and the legacy of the global financial crisis have driven down equilibrium real interest rates.”

That, in turn, has given the ECB less room to use interest rate policy alone to help boost economic activity, and forced it, like the Fed, to resort more often to other measures – bond-buying for example – when economic conditions weaken.

The BOJ led the way down that path early this century.

The aims of the new U.S. and European inflation strategies, and those pursued so far unsuccessfully in Japan, are the same: Get the pace of price increases high enough so inflation-adjusted interest rates can also increase, giving the central banks room to use rate cuts as their main policy tool in times of stress.

CHASING AN AVERAGE

The concept of using inflation averaging has been slow to evolve. All three central banks at first adopted simple inflation targets of 2%, trusting that they understood inflation dynamics well enough to hit that level and stay there.

They didn’t.

Over time, they realized that between technology, globalization, demographics and other factors, inflation had become difficult to budge. Even more problematic, the continued “misses” against a well-publicized target risked resetting public expectations that inflation would remain weak.

Research by current and former Fed officials raised the stakes. They found that in a situation where equilibrium interest rates were low and central banks were repeatedly forced to cut their policy rates to near zero, inflation expectations would fall – permanently, a damaging outcome that would cement weak prices, wages, and growth as the norm.

Fed Vice Chair Richard Clarida, whose earlier academic research affirmed the advantages of simple inflation targeting, detailed this past January how subsequent studies by New York Fed President John Williams and others concluded more aggressive approaches were needed when interest rates were expected to keep collapsing to zero.

Interest rates stuck near zero “tend to deliver inflation expectations that, in each business cycle, become anchored at a level below the target,” Clarida said in a presentation to Stanford University’s Hoover Institution. “It can open up the risk of the downward spiral in both actual and expected inflation that has been observed in some other major economies.”

‘HISTORIC SHIFT’

The Fed’s new policy has been in place for just over 10 months. Its experience shows the challenges the ECB now faces.

The coronavirus pandemic and subsequent economic reopening have complicated the inflation outlook, with supply bottlenecks driving up prices more than – and perhaps for longer than – anticipated and a labor squeeze starting to drive up workers’ pay.

That has led to some new hawkish voices inside the Fed and hints at faster interest rate hikes from the U.S. central bank despite its stated promise to let inflation run above target “for some time.”

With the Fed yet to prove its new design in practice, bond markets have noticed.

The yield on the 10-year U.S. Treasury note, far from anticipating higher inflation and growth, has been falling, and on Thursday hit 1.25%, the lowest level since mid-February and a drop of nearly half a percentage point from mid-May.

As with the Fed, the ECB will have to translate its new strategy into policies that work.

The new strategy marks “a historic shift for the ECB,” by acknowledging inflation may need to exceed 2% at some point, wrote Andrew Kenningham, chief Europe economist for Capital Economics. But it “will not make it easy for the ECB to escape from the grips of low inflation.”

(Reporting by Howard Schneider; Editing by Dan Burns and Paul Simao)

Rookies and robots brace for first UK rate rise since 2007

Office lights are on at dusk in the Canary Wharf financial district, London, Britain,

By Fanny Potkin and Polina Ivanova

LONDON (Reuters) – Financial markets braced this week for what could be the Bank of England’s first rate rise in a decade – a step into the unknown for a generation of young traders who started work after 2007 but also for the state-of-the-art technology they use.

After a decade that included a global financial crash, numerous investigations into market collusion and relentless automation, trading floors at banks in London have been transformed in ways not obvious at first glance.

The newest kid on the block is not necessarily the rookie trader with a PhD in physics but the latest computer model or algorithm. How these models will perform under the almost novel circumstances of tightening monetary policy is as much a question as how the human neophytes will react.

Using past market data, assessments of demand, valuation models and even measures of how upbeat news headlines are, computers crunch the numbers, game the scenarios and buy or sell in the blink of an eye.

But shocks such as Brexit have shown that computer-driven trading can end in stampedes, or so-called flash crashes.

“You’ve got to weigh up the strength of the traders and the strength of the algorithms that have been developed and whether they can manage this kind of a process when the rate hike does come in,” said Benjamin Quinlan, CEO of financial services strategy consultancy Quinlan & Associates.

At Citibank’s expansive trading floor in London, the dealing room doesn’t look much different from a decade ago with traders hunched in front of banks of screens, the odd national flag perched on top, and television screens on mute.

But beneath the outward appearance, foreign exchange trading has undergone a seismic shift: more than 90 percent of cash transactions and a growing proportion of derivatives trades in the global $5 trillion a day FX market are done electronically.

So-called smart algos, or fully automated algorithmic trading programs that react to market movements with no human involvement, were virtually non-existent in 2007. Now, almost a third of foreign exchange trades are driven solely by algorithms, according to research firm Aite Group.

“Most of these algorithms haven’t really been tested in a rising interest rate scenario so the next few months will be crucial,” said a portfolio manager at a hedge fund in London.

To be sure, the U.S. Federal Reserve’s first rate rise in a decade in 2015 provided a dry run for this week’s UK decision – but the two economies are in very different positions and the knock-on effects on the wider financial markets of a Bank of England move are hard to predict.

 

ROOKIES AND ROBOTS

Much has changed since the Bank of England raised rates by 0.25 percent on July 5, 2007 to 5.75 percent. The first iPhone had yet to reach British shores, the country’s TVs ran on analogue signals and Northern Rock bank was alive and well.

Where once lightning decision-making and a calm head in a crisis were at a premium, the bulk of trading today is done by machines and the job of a foreign exchange sales trader is often little more than minding software and fielding client queries.

Itay Tuchman, head of global FX trading at Citi and a 20-year market veteran, said while the bank employs roughly the same number of people in currency trading as over the last few years, fewer are dedicated to business over the phone.

“We have an extensive electronic trading business, powered by our algorithmic market making platform, which is staffed by many people that have maths and science PhDs from various backgrounds,” said Tuchman, who heads trading for Citi’s global developed and emerging currency businesses.

London is the epicenter of those changes with the average daily turnover of foreign exchange trades executed directly over the phone down by a fifth to $566 billion in just three years to 2016, according to the Bank of England.

At Dutch bank ING’s London trading room, Obbe Kok, head of UK financial markets, said the floor now has about 165 people but the bank wants to make it 210 by the end of the year – searching mainly for traders attuned to technological innovations and keen on artificial intelligence.

The proportion of people employed in trading with degrees in mathematics and statistics has increased by a 58 percent over the last 10 years, Emolument, a salary benchmarking site, said.

“What banks have started to do is trade experience for technological skill and with electronic platforms growing, the average age on the floor is a bit younger,” said Adrian Ezra, CEO of financial services recruitment agency Execuzen.

 

TAPER TANTRUM

The increasing use of technology means traders can gauge the depth of market liquidity at the click of a button or quickly price an option based on volatility – a major change from a few years ago when they had to scour the market discreetly for fear of disclosing their interest to rivals.

Ala’A Saeed, global head of institutional electronic sales and one of the brains behind Citi’s trading platform FX Velocity, said its electronic programs process thousands of trades per minute.

Most of the currency trading models used by banks incorporate variables such as trading ranges, valuation metrics including trade-weighted indexes and trends in demand based on internal client orders to get a sense of which way markets are moving – and the potential impact of a new trade.

Nowadays, the models also incorporate sentiment analysis around news headlines and economic data surprises.

These electronic trading platforms also have years of financial data plugged into them with various kinds of scenario analyses, but one thing they have sometimes appeared unprepared for is a sudden change in policy direction.

Witness the market mayhem exacerbated by trend-following algorithms when Switzerland’s central bank scrapped its currency peg in 2015, or the taper tantrum in 2013 when the U.S. Federal Reserve said it would stop buying bonds.

Or Britain’s vote last year to leave the European Union.

Indeed, the biggest risk for financial markets cited by money managers in a Bank of America Merrill Lynch poll in October was a policy misstep from a major central bank.

 

EASY CREDIT, LOW VOLATILITY

One concern is that the rise in automation has coincided with a prolonged decline in market volatility as central banks from the United States to Japan have kept interest rates close to zero and spent trillions of dollars dragging long-term borrowing costs lower to try to reboot depressed economies.

While central banks have been careful to get their messages across as they end the years of stimulus, there are concerns about whether quantitative trading models can capture all the qualitative policy shifts.

For example, a growing number of investors expect the Bank of England to raise its benchmark interest rate to 0.5 percent on Nov. 2, and then leave it at that for the foreseeable future.

But futures markets are expecting another rate rise within six to nine months, injecting a new level of risk around interest rate moves and potentially boosting volatility.

Neale Jackson, a portfolio manager at 36 South Capital Advisors, a $750 million volatility hedge fund in London, said young traders have never seen an environment other than central banks supporting markets, and that has fueled risk-taking underpinned by the belief that “big brother has got our backs”.

“The problem these days is that there’s a whole generation of traders who have never seen interest rates, let alone interest rates hikes,” said Kevin Rodgers, a veteran FX trader and the author of “Why Aren’t They Shouting?”, a book about the computer revolution within financial markets.

 

(Additional reporting by Maiya Keidan and Simon Jessop; writing by Saikat Chatterjee; editing by Mike Dolan and David Clarke)

 

World Stocks hit one year high as Fed hike prospects fade

Traders work at their desks in front of the German share price index, DAX board, at the stock exchange in Frankfurt, Germany,

By Nigel Stephenson

LONDON (Reuters) – World stocks hit their highest in more than a year and the dollar fell sharply against the yen on Wednesday as expectations of a rise in Federal Reserve interest rates receded after weak U.S. economic data.

Emerging market shares led the charge, touching their strongest levels since July 2015 as investors sought yield with interest rates likely to stay low for a prolonged period.

But European shares dipped in early trade. The Stoxx 600 index  fell 0.2 percent led lower by banks, for whom rock-bottom interest rates promise tough times. The index nonetheless remained close to eight-month highs.

The top gainers in Europe were energy shares, up 0.7 percent, as oil prices rose, even though many market participants remained doubtful producers would reach a deal to freeze output.

Euro zone government bond yields fell as some investors bet the weak U.S. data, which followed weaker-than-expected jobs numbers on Friday, would pressure the European Central Bank to ease monetary policy further. Then ECB meets on Thursday.

“With a September rate hike looking less likely to happen, the ECB might be more pressured to come up with a decision this week on further measures,” said Benjamin Schroeder, senior rates strategist at ING.

In Asia, MSCI’s main Asia-Pacific stock index, excluding Japan was up 0.2 percent, having earlier touched its highest since July last year. This helped lift MSCI’s all-country world index to its highest since August 2015.

“When people think there’s no immediate rate hike from the Fed, then Asia and emerging markets are the place to go to, as investors seek yields,” said Toru Nishihama, senior economist at Dai-ichi Life Research.

Japan’s Nikkei index , however, retreated 0.4 percent as a strong yen hurt exporters.

DOLLAR, OIL

The dollar was last down 0.5 percent at 101.50 yen <JPY=>, having fallen as low as 101.18, its weakest since Aug. 16.

The dollar fell 1 percent against several major currencies on Tuesday after Institute for Supply Management data showing activity in the U.S. service sector slowed to a 6 1/2-year low in August and diminished already slim prospects for a Fed rate hike this month.

The dollar index, which measures the greenback against a basket of major currencies was flat. The euro was down 0.1 percent at $1.1245 while sterling, which topped $1.34 for the first time in seven weeks on Tuesday after the ISM data, pulled back 0.2 percent to $1.3412.

“Clearly, this is a challenging environment for the dollar,” said Petr Krpata, currency strategist at ING.

The Swedish crown rose around 0.2 percent to 9.52 per euro after the Swedish central bank kept interest rates unchanged, as expected.

Oil prices, which have been on a rollercoaster in recent days as expectations of whether a deal to curb a global glut can be reached have waxed and waned, edged up.

Brent crude, the international benchmark, gained 35 cents to $47.61 a barrel. It rose as high as $49.40 on Monday, having fallen to $45.32 on Sept. 1.

The reduced expectations of a Fed hike also lifted other commodities. Copper hit a two-week high at $4,683 a ton, while gold hit a 2 1/2-week peak above $1,352 an ounce before pulling back.

For Reuters new Live Markets blog on European and UK stock markets see reuters://realtime/verb=Open/url=http://emea1.apps.cp.extranet.thomsonreuters.biz/cms/?pageId=livemarkets

U.S. Dollar Lowest Level in 7 Weeks

An employee checks U.S. dollar bank-notes

By Sam Forgione

NEW YORK (Reuters) – The U.S. dollar hit its lowest level against the euro in nearly seven weeks on Wednesday following dovish comments from Federal Reserve Chair Janet Yellen that pushed out expectations for the central bank’s next interest rate hike.

The euro <EUR=> advanced to $1.1364, its highest against the dollar since Feb. 11, while the dollar hit a more than five-month low against the Swiss franc at 0.9592 franc <CHF=>.

The dollar index, which measures the currency against a basket of six major rivals, hit its lowest level in 12 days at 94.588 <.DXY> after posting its biggest one-day percentage decline since March 17 on Tuesday.

The ADP National Employment Report showed U.S. private employers added 200,000 jobs in March, above economists’ expectations. The data came ahead of the U.S. Labor Department’s more comprehensive March non-farm jobs report on Friday.

While the ADP data beat economists’ forecast for 194,000 jobs according to a Reuters poll, the data was not enough to halt the negative sentiment toward the dollar a day after Yellen stressed the need to be cautious in raising rates.

“It’s going to take more than one ADP number that was just okay to overcome Yellen’s dovish comments,” said Chris Gaffney, president of EverBank World Markets in St. Louis.

The dollar was on track to post its biggest quarterly percentage decline in five years, and was last down 4 percent for the first quarter.

The dollar’s losses accelerated against the euro after traders “covered” or reversed “short” bets against the euro once it crossed $1.1335, said Douglas Borthwick, managing director at Chapdelaine Foreign Exchange in New York.

The Australian dollar <AUD=D4>, which is closely correlated with commodity prices, soared to a roughly nine-month high <AUD=D4> of $0.7709 as oil prices – which are U.S. dollar-denominated – rose and became cheaper for holders of other currencies. <O/R>

U.S. crude was last up 2.8 percent at $39.36 a barrel <LCOc1>.

Against the yen, the dollar was last down 0.2 percent at 112.45 yen <JPY=> after touching an eight-day low of 112.02 yen earlier.

(The story was refiled to change the word in the analyst comment to “reversed” from “repurchased”, in the eigth paragraph)

(Reporting by Sam Forgione; Editing by Dan Grebler)

Federal Reserve Expected to Raise Interest Rates Wednesday

The U.S. Federal Reserve is widely expected to vote to raise a key interest rate for the first time in nearly a decade when it meets on Wednesday, according to multiple published reports.

The effects of such a vote could have wide-ranging implications throughout the economy, affecting things like interest on savings accounts, mortgages, auto loans and credit cards.

The rate the Federal Reserve is considering raising is called the effective federal funds rate. It deals with how banks borrow money from one another, thus setting a bar for all other lending.

The rate has been close to nothing since 2008, during the Great Recession. The rate was at 5.26 percent in July 2007, according to the Federal Reserve Bank of St. Louis, but the bank lowered the rate nearly every month through the end of 2008 to help jumpstart a struggling economy.

The rate has not been raised since that. In fact, it hasn’t been raised at all since June 2006, when the Federal Reserve raised it to the 5.26 percent level at which it stood until the recession.

But the economy is in better shape than it was during the recession. The civilian unemployment rate is down to 5 percent, according to the Federal Reserve Bank of St. Louis. In 2009, after the fallout from the financial crisis, it reached 10 percent. That was its highest level in 27 years.

Why is the Federal Reserve even considering raising the rate again? Essentially, the bank needs to find a balance that ensures the economy stays stable and healthy.

The Washington Post reported that if the Federal Reserve waits too long to raise the rate, it could create bubbles in the stock market or rampant inflation, where prices rise at a rate that employee wages aren’t able to match. But if the Federal Reserve hikes the rate too early, it could jeopardize the recovery — especially if people can’t obtain affordable loans for what they need.

A vote to raise the rate is seen as a vote of confidence for the economy. CBS News reported if the Federal Reserve doesn’t act Wednesday, especially because just about everyone on Wall Street is expecting it to, it could lead to a decline in the stock market because it would suggest the bank’s policymakers think the economy couldn’t cope with a rate increase, even one that’s fractional.

And any rate increase is expected to be slight. CNN reported that the Federal Reserve is expected to raise rates slowly, from its current level of about .12 percent to a new level near .25 percent. Any effects on the economy aren’t expected to be felt for several months, according to the report.

Still, some question the timing of the increase and whether the economy is truly as healthy as evidence suggests.