Federal Reserve’s rate move will make doves cry

The Federal Reserve wants to avoid sparking another taper tantrum. That will be easier said than done.

In May 2013, when thenchair Ben Bernanke said that the Fed could begin winding down quantitative easing “in the next few meetings,” he sparked a sell-off in Treasuries that sent the yield on the 10year note from 1.94 per cent to 2.9 per cent in three months.

By then the Fed was having second thoughts, in part because it worried the rise in long-term rates was damping the economy. It didn’t begin scaling back bond purchases until the start of last year.

If it mishandles communicating its plans for raising rates, it risks a repeat.

The Wall Street Journal’s monthly survey of economists shows that nearly threequarters of forecasters expect the Fed to begin raising its target range on overnight rates at its September meeting.

The median federal-funds forecast for year-end is 0.625 per cent, which implies a target range of 0.5 per cent to 0.75 per cent — implying two quarterpoint increases.

That reflects a view that the economy will rebound from the weak first quarter, allowing the Fed to finally lift rates. It also seems squarely in line with what Fed officials expect. But investors see things differently.

Federal-funds futures, which price off overnight interest-rate expectations, imply the chances of a rate increase by September are less than 50 per cent and price in just one increase in the target range.

This may reflect worries that some sort of shock disrupts the Fed’s plans, rather than a straight forecast of what it will most likely do. It seems like investors have a more dovish take than the economists.

One reason Fed officials have been saying markets need to figure out where rates are headed, rather than expect signals from the central bank, may be to inject a little more uncertainty into dovish investors’ calculations.