Bond Traders More Sure of December Rate Hike This Year Than Last

(Bloomberg) -- If history is any guide, the bond market is ready for the Federal Reserve to pull the trigger on interest rates in December.

Futures imply a 59 percent chance of a quarter-point boost by year-end. That means traders are further along in gearing up for a hike than they were last September, when the probability of a 2015 hike was 41 percent. Less than three months later, the Fed raised rates from near zero.

The question of the bond market’s preparedness is a crucial one for policy makers. The Fed’s decision to hold off on raising rates this year has fueled speculation the central bank is as attuned to traders’ positioning as it is to economic data. As officials repeatedly talked up the possibility of a hike only to stand still, traders have been reluctant to ramp up bets on a move. Yet strategists say the example of 2015 indicates traders today are as ready as they need to be.

“The market is definitely getting prepared,” said Kathy Jones, chief fixed-income strategist at Charles Schwab & Co. in New York. “The market’s more ready than it was at this time last year, and there’s plenty more time to get ready still.”

2015 Precedent

All it took in the final quarter of 2015 to surpass the current perceived probability of a hike was a much stronger-than-expected labor report, which came days after policy makers said in late October that they’d consider tightening at their December gathering. Hawkish comments from a Fed president provided further fuel.

Fast forward to this year, and traders are gearing up for events that may either tip the scales further toward a policy move in coming months, or quash bets that a hike is approaching.

Employment figures to be released next week may show the U.S. added 170,000 jobs in September, after an increase of 151,000 in August, according to the median forecast of economists surveyed by Bloomberg. The end of October will bring the government’s report on third-quarter economic growth. An Atlanta Fed estimate for the figure has tailed off to a 2.4 percent annualized pace, from 3.5 percent in early September.

Turning Point

Last year, payrolls data for October spurred a ramp-up in rate-hike expectations. After traders learned the economy added the most jobs of any month in 2015, they priced in a 68 percent chance the Fed would move in December, up from coin-toss odds earlier that week. The calculations of the market-implied probability assume the effective fed funds rate trades at the middle of the new target range after the next hike.

The next big jump in market-implied probability of a hike came after San Francisco Fed President John Williams said in November that he saw a “strong case” for a December rate increase. The following trading day, the probability climbed to 74 percent.

Current expectations for the labor figures next week “certainly would be strong enough to keep the Fed on the path to hiking rates, especially if wage data comes in on the firmer side, barring any big change in financial conditions,” said Jones at Charles Schwab.

To contact the reporter on this story: Eliza Ronalds-Hannon in New York at eronaldshann@bloomberg.net. To contact the editors responsible for this story: Boris Korby at bkorby1@bloomberg.net, Mark Tannenbaum, Michael Aneiro