Wall Street now believes there's a better chance of a September Fed hike, thanks to a rising benchmark interest rate that some experts believe will influence the central bank.
The three-month London Interbank Offered Rate — more commonly known as Libor — is around the highest level it's been since May 2009. The rate represents how much banks around the world charge each other for short-term loans, and helps determine global rates as well.
While Libor had been dwelling below 0.3 percent for more than two years, it began rising a year ago and has been climbing steadily since late 2015. Much of the gain can be attributed to money market regulatory changes happening in October that are pushing on short-term rates. However, there could be more to it.
Libor over the past year
Some experts believe it's a telltale sign that the Fed could get pushed into hiking rates before it wants to and before much of the market expects it to. CME traders who bet on fed funds futures currently assign a 24 percent chance of a move in September, which while low is considerably higher than it's been lately. Just a few days ago, the chance was 12 percent.
After all, the Fed enacted its first hike in more than nine years in December 2015, just as Libor began its ascent. Banking analyst Dick Bove believes that if Libor continues to move higher in the weeks ahead, that could trigger a Fed move.
"All indications are that the fed funds followed Libor rather than the other way around," Bove, vice president of equity research at Rafferty Capital Markets, said in a note to clients. "If this is the case any further movement in Libor is likely to force the Federal Reserve to raise rates the fed funds rate again."
The market is anxiously awaiting remarks Friday from Fed Chair Janet Yellen, who is scheduled to speak at the central bank's annual summit in Jackson Hole, Wyoming. Ostensibly a speech on the Fed's "monetary policy toolkit," the market will be looking closely for clues about whether the Fed will hike this year, and more specifically about what will cause it to act.
Peter Boockvar, chief market analyst at The Lindsey Group, said the 0.5 percentage point move since December — double the Fed's quarter-point hike that month — already has done some of the heavy lifting.
"It does lessen the importance of the Fed raising rates, since the market did it for them," he said, adding that he doesn't necessarily think the Fed will move in September but there's a better chance of that happening than the market anticipates.
"The Fed's worried about getting trapped," Boockvar said.
However, anticipation that rising Libor rates will force the Fed's hand could be misplaced. Only about half the 17 basis point gain since late June can be attributed to Fed expectations, according to Bank of America Merrill Lynch.
The $2.71 trillion money market industry is about to undergo substantial changes, including incentives to move investors out of prime funds, which invest in Libor-linked debt, and into government funds, which are focused on Treasurys and government agency debt. That is forcing Libor yields to go higher to compete for investor dollars.
However, the extent to which that would play into rate-hike deliberations is unclear. Fed officials have not mentioned rising Libor rates in their public comments.
Yellen is "completely data dependent" and unlikely to use Libor shifts to formulate policy, said Quincy Krosby, market strategist at Prudential Financial.
"Because we've had these downside surprises from some of the key data points she watches, she's going to be very careful," Krosby added. At Jackson Hole, "she's going to continue the theme that every meeting is live, that the Fed remains data dependent."