Saturday, June 24, 2006

Rates decision countdown begins in earnest

Rates decision countdown begins in earnest
By Christopher Brown-Humes
Copyright The Financial Times Limited 2006
Published: June 24 2006 03:00 | Last updated: June 24 2006 03:00

Worries about where US interest rates are heading unsettled investors yesterday as the countdown to next week's Federal Reserve meeting began in earnest.

A seventeenth consecutive quarter point increase in US interest rates to 5.25 per cent next Thursday is fully priced in by the market.

But speculation that the Fed might lift rates by50 basis points was enough to keep investors on edge.

The futures market seemed to be giving a slim probability - just 12 per cent - to the chance of a 50bp rise.

The more widely held view is that rates will be increased by 25bp next week, with the strong probability of a further 25bp at the Fed's next meeting in August.

Some economists predict that the Fed will lift interest rates to 6 per cent overthe next year as it continues its battle to hold down inflation.

Fears over higher interest rates played out in theUS Treasuries market yesterday.

The yield on the benchmark 10-year note rose to a four-year high above 5.21 per cent, while the yield on the two-year note, which is particularly sensitive to Federal Reserve monetary policy shifts, rose above 5.25 per cent, its highest since Dec-ember 2000.

The unsettled mood spread into the corporate bond market, with a sell-off in high-yield debt, suggesting rising risk aversion for this asset class.

"There is a certain amount of risk-aversion in the market, given that US interest rates could go higher than previously thought.

"There is no doubt that the macro economic conditions in the credit market are deteriorating, although it is a slow development," said Gary Jenkins, head of credit strategy at Deutsche Bank.

Interest rates are also being increased in the eurozone and the Bank of Japan is expected to move away from its near zero interest rate policy in the next few months.

"I am concerned that we may be entering a phase of 'monetary overkill' ascentral banks worldwide continue to remove liquidity from the system," saidNick Parsons, head ofmacro research at Commerzbank.

"Either short rates will rise too much or long rates will rise too much. Either way, the implications for the real economy, in the US and globally, could be quite serious for the markets."

Equity markets found it hard to make progress after a weak close to Wall Street on Thursday and a weak start yesterday. By mid-afternoon on Friday, the S&P 500 was 0.4 per cent higher and 0.1 per cent lower for the week. The Nasdaq was 0.5 per cent higher leaving it up 0.2 per cent for the week and the Dow Jones Industrial Average was up 0.3 per cent, a gain of 0.3 per cent for the week.

Weaker than expected economic data did little to help the mood on Wall Street yesterday.

US durable goods orders for May were down 0.3 per cent month on month, whereas the consensus had been for a rise of 0.4 per cent.

European shares held steady with the FTSE Eurofirst 300 index rising0.1 per cent to 1,283.03 yesterday, taking its gains over the week to 1.8 per cent. In Japan the Nikkei 225 Average fell 0.08 per cent to 15,124.04, but the index was 1.6 per cent higher on the week.

Tim Harris, strategist at JPMorgan Private Bank, said: "We expect conditions to remain volatile over the next three months.

"We need to know that the Fed is on top of inflation but not killing growth before the current unsettled period comes to an end."

The dollar reached atwo-month high against the euro, the yen and the Swiss franc, while hitting a seven-week high against sterling yesterday as it benefited from talk of higher US interest rates and a sell-offin some emerging market currencies.

Oil prices remained above $70 a barrel, as investors fretted about tightness inUS gasoline stocks ahead of the peak summer driving season.

Worries about possible disruption to supplies during the hurricane season has also helped to keep prices high.


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