By Rahul Karunakar
(Reuters) – The Federal Reserve will raise interest rates next week in response to a series of strong economic data, according to all of more than 100 economists polled by Reuters, with two more hikes likely to follow later this year.
Hawkish comments from several Fed officials have pushed interest rate futures markets to bet on a rate hike on March 15, with the probability now at 90 percent, up from just 30 percent early last week, according to CME Group.
Similarly, the proportion of economists forecasting a March hike has moved from just over 10 percent in the last Reuters poll to 100 percent in the latest one, conducted March 3-9, with a median 90 percent probability given of such a move.
Asked for the likely reasoning behind the Fed’s sudden change in tone, poll respondents said improving economic data was the top pick, followed by stock markets hitting new record highs, as well as hints of global inflation heating up.
“Last week, Fed officials virtually pre-announced a rate hike and have effectively said it is a done deal,” said Jim O’Sullivan of High Frequency Economics, the top forecaster of U.S. economic data in Reuters polls for 2016, the second year in a row he achieved that distinction.
“Definitely a part of it was data, with the labor market numbers looking quite strong, and a part of it as well is the positive tone in the financial markets, which made them (the Fed) more confident and feel the time was right,” said O’Sullivan.
Two more 25 basis point rate increases are likely to come in the second and fourth quarter this year, respectively, the latest poll showed, taking the federal funds target rate to a range of 1.25-1.50.
Calls for three rate hikes this year now match policymakers’ own views. Around 80 percent of economists say the third rate hike will be delivered by the end of the year, compared with about 30 percent in the previous poll.
“Data on the labor market, inflation, and financial conditions have presented the Committee with a compelling case for a hike at its March meeting,” noted economists at Morgan Stanley. “Markets will be keenly focused on how the Fed messages the path beyond. A more hawkish path is in store.”
However, the overall growth and inflation outlook based on economists’ forecasts this year is still muted, underscoring a wide gap between how they expect the economy to perform and what financial markets are currently pricing in.
Stock markets have been on a tear since Donald Trump was elected U.S. president on promises of sweeping tax cuts to individuals and businesses as well as deregulation, which has lit a fire under financial shares.
The economy will expand at an annualized rate of 2.0-2.4 percent each quarter according to the median view in the latest poll, well short of the more than 3 percent mooted as a target by the new U.S. administration.
The lowest forecast was 0.9 percent and the highest was 4.0 percent. The full-year forecast median was 2.3 percent.
Predictions for core PCE inflation, which the Fed closely watches, haven’t moved much in each month of Reuters polls since December, now in a 1.7-1.9 percent range for this year, according to medians. While the jobless rate has fallen well below 5 percent, inflation has yet to pick up significantly.
The latest shift in Fed expectations sent yields on the U.S. two-year Treasury note – most sensitive to fed funds rate changes – to the highest levels in more than 7-1/2 years. Those yields are up over 20 basis points since early last week.
The last time there was such a sudden swing in expectations in Reuters polls was in July last year, after the initial shock from Britain’s vote to leave the European Union. Back then, expectations for a Fed lift-off pushed back three months from September to December 2016.
Expectations remained steady afterward until the Fed delivered its second rate hike in the current cycle in December, as correctly predicted by that July poll.
What has changed this time, according to HFE’s O’Sullivan, is greater optimism in financial markets.
“That is very different from a year ago after they (the Fed) tightened in December 2015 and then financial markets tanked in January and February, and financial conditions tightened. So, it is very different this year,” he said.
(Polling and analysis by Sujith Pai and Shrutee Sarkar; Editing by Ross Finley and Chizu Nomiyama)