Odds of Rate Hike Rise for 2016

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It probably sounds like a stupid joke to address a market sell-off at this point in August. After all, the Dow Jones Industrial Average, the S&P 500 Index and the Nasdaq have all been hitting all-time highs. But now we have bond yields starting to rise modestly, and the logic behind the move is that perhaps the Federal Reserve’s ambition to raise interest rates is not dead for all of 2016.

Before anyone hits the panic button here, it is important to understand that market volatility has all but died. Trading volume has been light. Valuations are incredibly high (18.1 times forward earnings for S&P 500). We have two of the most unpopular presidential candidates in history. And we have not seen a market pullback in too long.

Tuesday’s weakness is on the heels of a televised interview of William Dudley, the president of the New York Federal Reserve. Dudley basically said that the U.S. economy should strengthen in the second half of 2016, and he said that the presidential election was not going to skew the Fed’s opinion.

Now we also have Atlanta Fed president Dennis Lockhart, who is not a Federal Open Market Committee voting member, has indicated that one rate hike in 2016 might be appropriate as the economic fundamentals remain strong enough.

Whether or not the Fed hikes rates in 2016, it is important to understand that the world just cannot tolerate much higher interest rates. If short-term rates in the United States were to rise to 1.0% gradually over the next year or two, it would likely not signal the end of the world.

As a reminder, many rates in Japan and Europe are still negative. Yes, you have to pay to get your money back!

Fed funds futures are not factoring in a chance that the fed funds rate will go above 0.50% with a 100% certainty until January of 2017. They are also not indicating a 100% priced-in chance of fed funds reaching 1.0% even into early 2018.

The odds might have risen for a rate hike in 2016. September may even be considered a “live” meeting, meaning there is a chance that a rate hike could come. Just keep in mind that interest rates sure look like they are going to remain lower for quite a long time.

Price snapshots at 1:05 p.m. Eastern Time:

  • S&P 500 at 2,183.98 (-6.17)
  • DJIA at 18,592.94 (-43.11)
  • NASDAQ at 5,243.41 (-18.60)
  • US 10-Year Treasury Yield 1.58% (up 7 bp since Fri.)
  • US 30-Year Treasury Yield 2.29% (up 6 bp since Fri.)
  • Gold $1,346.80 (+$0.18)
  • WTI Crude $46.48 (up $0.74)