Traders' expectations for a rate hike from the Federal Reserve in January briefly hit a three-month low on Friday as unrest continued in the Middle East and a powerful earthquake and tsunami struck Japan, killing at least 1,000 people and destroying miles of coastal development. January federal fund futures rose 1.5 ticks on Friday to 99.71, marking the highest level since early November.
-- Prices of January fed funds contract hit 3-month high
-- Chances of rate hike in January seen diminished
The earthquake that hit Japan was the largest in the country's recorded history. The news caused an immediate flight to quality trade that boosted Treasury prices and fed funds futures. The January 2012 futures now imply a 16 percent chance the Fed will raise rates to 0.50 percent from 0.25 percent before the end of the year, down from a 22 percent chance of such a move on Thursday. On February 14, the January futures implied a 92 percent chance of such a rise in interest rates.
Fed fund futures now fully price in an interest rate of 0.25 percent in December. In mid-February the futures were fully pricing in a rate of 0.25 percent as soon as September. Jim Lee, head of short-term rates strategy at RBS Securities in Stamford, Connecticut, said the run-up in futures was also related to ongoing protests in the Middle East.
"It's everything going on, it's not one thing," he said. In Europe, investors trimmed their expectations of how aggressively the ECB would hike eurozone interest rates on Friday with global macroeconomic shocks prompting some short-term caution over the growth outlook.
Overnight rates corresponding to the European Central Bank's next meeting in April were around 7 basis points off their recent peak, suggesting investors saw some risk the bank would back away from the strong signal it sent last week that rates would begin rising next month. The move came as pessimism grew over whether European leaders will deliver on their promise of comprehensive measures to tackle the debt crisis at an end-March summit.
The potential impact on global growth from Friday's huge Japanese earthquake and ongoing conflict in Libya also helped temper bullish economic sentiment across asset classes. The overnight index swaps curve suggested the market was now pricing in two hikes by the ECB's December meeting, with a 75 percent chance of a third, compared to earlier this week when three rises were fully priced in.
An implied overnight rate of 1.66 percent by December's meeting already looked too high for some given the risks that an aggressive rate-hiking cycle would squash growth in the eurozone's peripheral states and force a policy rethink. The ample surplus saw overnight rates edge lower, relieving pressure further up the curve where three month Euribor slipped to 1.173 percent.