September? December? Fed's not saying. But what's more important is when the second rate hike will be

The focus of investors now shifts to next week's employment report, which will show an increase of 220,000 jobs in July.
The focus of investors now shifts to next week's employment report, which will show an increase of 220,000 jobs in July.PHOTO: BLOOMBERG

NEW YORK (BLOOMBERG) - The Federal Reserve needs a little longer to decide when to raise interest rates for the first time in nine years. Traders and investors are more interested in when the second increase will be.

Wednesday's Fed's policy statement noted continued improvement in labour markets while failing to provide clear guidance on whether policy makers plan to increase rates when they meet in September, or wait until December. Regardless, futures show traders are sticking to their bets that the pace will be even more gradual than the US central bank forecasts.

"What's more important for the market is not when the Fed begins liftoff but when will be the second time the Fed raises rates," said Gary Pollack, who manages US$12 billion as head of fixed-income trading at Deutsche Bank AG's Private Wealth Management unit in New York. "That's the more critical question for the market because that will give us an idea of the Fed's pace and methodology in normalization."

The Fed's June 17 rate projections show the median forecast for their benchmark rate at 0.625 per cent by the end of the year, rising to 1.625 per cent in 2016. Markets aren't pricing in a second rate increase until June 2016, according to Royal Bank of Scotland Group.

The focus of investors now shifts to next week's employment report, which will show an increase of 220,000 jobs in July with average hourly earnings rising 0.2 per cent, according to the median estimate of economists surveyed by Bloomberg.

The Fed is navigating in uncharted waters as it trying to step back from more than six years of virtually zero interest rates. Those efforts are complicated by bond-market inflation expectations, which are the lowest since January as prices for commodities including oil have plunged amid turmoil in China's stock market.

"The labour market continued to improve, with solid job gains and declining unemployment," the Federal Open Market Committee said in Wednesday's statement. It said that "underutilization of labour resources has diminished," dropping the modifier "somewhat" to describe the change.

In focusing on labour, the Fed is highlighting the part of the US economy which has been posting the strongest, most consistent results. The US has averaged 208,000 added jobs each month in 2015 after producing a monthly average of 260,000 last year.

Traders are pricing a 39 per cent probability that the Fed raises rates at or before the September meeting, based on the assumption that the effective fed funds rate will average 0.375 per cent after liftoff. That compared with a 40 per cent probability before the Fed announcement.

The likelihood of a rate increase at or before the December meeting is about 70 per cent.

"The most important thing the Fed is trying to communicate is not the timing of the first liftoff, but the pace, and continuing to try to counsel the markets about the pace being gradual," said Roger Bayston, senior vice president and director of fixed income at the Franklin Templeton fixed-income group.