A majority of Wall Street's top bond firms don't see the Federal Reserve raising interest rates before the second half of next year and most also now believe the Fed won't start shrinking its massive balance sheet before it lifts rates, a Reuters survey showed on Friday.
Eleven of 18 primary dealers, or the banks that deal directly with the US central bank, said the Fed's first rate increase would occur between July 2015 and June 2016, the survey found. All but four of the 22 primary dealers responded to the survey. This view that ultra-loose policy would continue for some time persisted in the wake of Friday's monthly employment report, which showed employers added more than 200,000 jobs for a fourth straight month in May. While supporting the notion the US economy is on a steady footing, it also suggests it is not growing quickly enough to rush a "lift off" in Fed policy rates, analysts said.
"It doesn't change much on the policy front," Thomas Simons, money market strategist at Jefferies & Co in New York said of the government's latest payrolls report. Economists remain concerned about meager wage gains and the disappointing level of job creation in higher-paying industries. Some Fed policy-makers recently signalled these soft patches in the labour market will likely cause the Fed to leave rates at their historic lows for longer.
"All the chatter from them has been lower rates for a longer period," Simons said. As the Fed has been winding down its third round of the large-scale bond purchases this year, some Fed officials in recent weeks have cautioned against ending reinvestments of Treasuries and mortgage-backed securities before a rate hike. They said such a move might spook traders and disrupt markets.
In the latest Reuters survey, 12 of 17 Wall Street firms expected the Fed would stop reinvesting the proceeds from maturing bonds it holds on its $4.3 trillion balance sheet after or around the same time as the first rate increase. A month ago, 14 of 16 primary dealers polled expected such a move by the end of 2015.
When the Fed does raise rates, most dealers said, it would stop using a range for the fed funds rate and return to targeting a specific rate level, as it customarily did before the financial crisis. Since December 2008, the Fed has targeted a range of zero to 0.25 percent for that key policy rate.
In Friday's survey, seven dealers forecast the Fed would adopt a rate target of 0.25 percent when it begins to raise rates, and seven projected it would go to 0.50 percent. Just two saw the Fed sticking with a rate range, with both of those dealers seeing the range lifted to 0.25 to 0.50 percent. Regarding the Fed's progress in its tightening regime, most dealers expect policy-makers to end rate increases at a lower level than in the past.
Among 15 primary dealers, their 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 4.00 percent estimate in the most recent statement from the Federal Open Market Committee, the central bank's policy-setting group. While US interest rates might go up by the latter part of next year, the European Central Bank loosened policy on Thursday including dropping its deposit rates into negative territory. The ECB's move in an effort to avert deflation in the euro zone is not unlikely to change the Fed's own policy path. Analysts expect it would keep a lid on long-term borrowing costs globally.
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