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Rate Hike? When??

MarketsMuse.com update courtesy of extract from Feb 16 CNBC reporting by Alex Rosenberg

Alex Rosenberg, CNBC
Alex Rosenberg, CNBC

There’s a major debate brewing in the financial markets, and it concerns the most important potential event of the year for stocks and bonds alike: the timing of a Federal Reserve rate hike.

In one corner are the economists. Many of those looking primarily at the state of the recovery say that the Fed will likely raise its key federal funds rate in June.

On the other side are traders, who say that current market dynamics—and prior experience with the central bank—tell them that a rate hike isn’t coming in 2015.

cnbc feb 16 rates yellen azous markowska

What the Fed actually chooses to do, of course, will have a profound impact on financial market, and perhaps on the economy as well. The federal funds rate, a critical short-term rate at which banks can lend to one other, has been kept ultra-low by the Fed since the financial crisis days of December 2008.

Now, many economists expect that the Fed is finally set to shift from ultra-low levels, given the strong state of the labor market.

With the unemployment rate declining and payrolls data showing some 250,000 payroll gains a month, “the U.S. labor market is screaming for policy normalization,” as Societe Generale economist Aneta Markowska put it in a recent note.

If the economists are right, a hint at a June rate hike could come as soon as Wednesday, when the Fed will release the minutes of their last policy meeting. If the minutes find them gushing about growth and unbothered by economic and geopolitical problems overseas, it could serve as a reminder for investors that a June hike is still on the table. So, too, could the congressional testimony of Fed Chair Janet Yellen in the following week.

The Fed is “much closer to hiking then putting it off,” said Neil Azous of Rareview Macro, a firm that advises large investors. After all, “it is hard to argue from an economist’s perspective that they shouldn’t at least start the process. Their models are telling them to, regardless of the problems abroad in Europe and Asia.”

Strong job creation, especially if February’s payrolls top expectations, could also hint at a tightening. “If the job market holds anywhere close to what it’s been running at, then yeah, we’ll get a hike,” agreed Deutsche Bank economist Joseph LaVorgna. “I don’t see why the Fed wouldn’t go in June.”

Still, that sentiment is clearly not reflected in the market. Fed funds futures are implying just a 20 percent chance of a rate hike in June, according to CME Group’s FedWatch tool.

Indeed, if Yellen does give a hint in the weeks ahead that a June rate hike is possible, “the fixed income market would re-price swiftly and painfully against the consensus long position,” Azous said.

In other words, rates (which move inversely to bond price) could rise dramatically. And that, in turn, could have a profoundly negative impact on stock prices. Continue reading