For bond traders, there’s little doubt about the path the Federal Reserve will take on interest rates.
They aren’t fully pricing in another increase until February, while driving a gauge of expected volatility in Treasuries to the lowest since 2014 this month. That’s the sort of hubris that can get them burned, according to Jerome Schneider, a money manager at Pacific Investment Management Co. and Morningstar Inc.’s 2015 fixed-income fund manager of the year.
“Investors shouldn’t be lulled into complacency that the Fed isn’t going to be in play,” Mr. Schneider said Monday at PIMCO's office in New York. “The Fed will continue to be data-dependent and really use gradualism in every approach,” he said, “but simply assuming you are going to be in the 25 to 50 basis point range for the next few years seems to be a little bit conservative.”
Futures markets assign zero probability to a rate increase when the Federal Open Market Committee concludes its two day meeting Wednesday, and only a 20% chance of a move in June, even after evidence that some officials argued in favor of an April rate increase at their last meeting. Fed Chair Janet Yellen last month said global economic risks could slow the pace of tightening despite signs of U.S. economic strength, after policy makers in March cut their median forecast for 2016 rate increases to two from four.
Bank of America Merrill Lynch’s MOVE Index fell to 67.89 Monday, down from as high as 97.94 on Feb. 11. The gauge, which measures volatility based on prices of over-the-counter options on Treasuries maturing in two to 30 years, has averaged 92.97 since the start of 2007. Futures traders aren’t fully pricing in another rate increase until next year, based on when the overnight rate implied by fed funds futures contracts first climbs above 0.625 percent -- the midpoint of the range expected in the next hike.
Markets have been whipsawed before as the Fed’s desire to tighten policy clashes with central banks abroad maintaining or increasing stimulus amid tepid global economic growth and weak inflation. With traders so certain of the Fed’s gradual path, the market could move if policy makers so much as hint at a June rate increase on Wednesday, said Kathy Jones, New York-based chief fixed-income strategist at Charles Schwab & Co.
“Will the statement be more hawkish than the market expects? That’s a possibility,” Ms. Jones said. “The market’s very sure of itself right now,” she said, “and that relative complacency could create a bit of a surprise.”