Investors trimming bets on September interest rate hike

Investors are underpricing the chances of the Federal Reserve raising interest rates next month, according to Pacific Investment Management Co. Options on rates and currencies indicate investor skepticism may be growing that the first increase since June 2006 will come at the Fed's Sept. 16-17 meeting. The odds for that had dropped to 46% on Wednesday from 54% almost two weeks ago. That's based on fed-funds futures and on the assumption that the effective rate will average 0.375% after the increase. “We think the odds are a little higher,” Anthony Crescenzi, an executive vice president at Pimco, said in an interview. Most recent communications from the Fed “have been making it clear that the bar for a hike on Sept. 17 is fairly low,” he said. The two-year U.S. Treasury note yield fell two basis points to 0.71% as of 11:53 a.m. New York time. That's below the 0.76% reached Aug. 5, its highest since April 2011. Two-year Treasury futures contracts expiring in September were little changed at 109 15/32, below their 2015 high posted in July. INVESTORS NOT BOOSTING BETS The cost of short-term options on U.S. rates are below highs seen earlier in 2015 and are near the year's average, signaling investors haven't boosted bets for an imminent increase in official borrowing costs. One-month option premiums on three-year interest-rate swaps are at about 50 basis points, compared with the year's average of 49 and a March peak of 64, according to data compiled by ICAP. While higher rates may attract more investors to the U.S. and push up its currency, a benchmark of anticipated dollar moves against the euro is indicating expectations of a jump are subsiding. Implied volatility in the euro-dollar exchange rate, a gauge of price swings in that period including the Fed meeting, fell 12 basis points, or 0.12 percentage point, to 9.62% Wednesday. That's down from a 3 1/2-year high of 15.32% posted on June 29, after Greece sparked turmoil in markets by announcing a referendum on its financial aid package. The year-to-date average is 11.55%. While the central bank will offer further information to the market when it publishes the minutes from the July 28-29 Federal Open Market Committee later Wednesday, Mr. Crescenzi doesn't expect it to change his view. EXCLAMATION POINT “Maybe it'll act as an exclamation point to other communications and other scenarios that the market itself has painted in terms of what to expect,” he said. “I'm not looking personally for a lot, nor is Pimco, from the minutes, because the Fed's already made it clear.”