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Stock selloff starting to cast doubt on rate increases

Traders are signaling that the abrupt pullback in high-flying risk assets is likely to weigh on interest-rate policy as Federal Reserve Chair Jerome Powell takes the helm.

That’s the story from Eurodollar futures, where the spread between December 2018 and 2019 contract yields fell by three basis points today, the most this year. The move indicates reduced wagers on interest-rate increases next year as U.S. stocks continued their slide after the S&P 500’s worst week in two years. The market-implied odds of an interest-rate increase in the second, third and fourth quarters of 2018 also edged lower today.

The interest-rate market moves were relatively small and likely reflect some profit taking after January’s run-up, but indicate that investors are betting that the global equity selloff is going to be factored into the Fed’s decision-making process. The thinking is that policy makers would hold off on interest-rate increases to avoid adding to the volatility in equities, acting on the unofficial “third mandate” for the monetary authority to try to ward off wild swings in global markets.

Going into this week, projections called for the Fed to raise rates about five times by the end of next year.

January was marked by increased wagers on Fed tightening in 2019. The spread between the end-of-the-year futures contracts roughly doubled to 36 basis points by Feb 2. as investors bet an extended episode of synchronized global growth and the most accommodative U.S. financial conditions on record would compel policy makers to raise borrowing costs.

David Zervos, the chief market strategist at Jefferies Group LLC, suggested that this tumult in equities is the first test for Powell as investors monitor his reaction to softness in stocks. The evolution of financial conditions has assumed a more prominent role inside the U.S. central bank as a guide to the trajectory of its policy rate.

“Folks want to know if the strike for the ‘Fed put’ will move materially under his stewardship,” Zervos wrote in a note to clients today. “With this particular administration, he could start to feel political heat much more quickly than Ben or Janet ever did.”

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