With global equities seeing severe bouts of volatility and some major European indexes entering bear market territory, traders and investors have thrown down the gauntlet to the U.S. Federal Reserve, which had been edging towards a period of tighter monetary policy.
There have been no hints of a change in policy from the Fed amid these major market moves, but investors are now feverishly pushing back their expectations for a rate hike.
The 30-Day Fed Funds futures - used to gauge investors' views on the likelihood of policy changes - now show a probability of 37.3 percent for a hike on-or-before the Fed's September meeting next year, according to data from the CME Group. On Tuesday - before Wednesday's steep drops in equity markets - that probability was 57.1 percent, and last month it was 84 percent.
This change in expectations was accompanied by a wild ride in the Treasury market on Wednesday, and what some are calling a "mini-crash" in yields. The interest rate on the 10-year note was trading at around 2.1079 percent in early European trade Thursday, after falling as low as 1.865 percent Wednesday to touch 17-month lows. Bond prices move inversely to yields.
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Michael Gallagher, director of research at investment consultancy IDEAglobal, said that falling oil prices and the equity selloff meant investors now felt the Fed couldn't tighten in 2015 - and would have to wait until 2016.
"That's the most important thing that happened," he told CNBC on Thursday. "There was an awful lot of liquidation of short U.S. Treasury positions and that was the key driver behind the volatility yesterday."
Cheaper oil prices and a more dovish Fed might usually be considered beneficial for stocks, but Gallagher said that investors were now more focused on a future of mediocre growth. Weak oil prices are set to weigh on inflation rates for the next two years, and mean the Fed and Bank of England are less likely to tighten policy, he added.
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Nomura strategist Bob Janjuah said he believed the Fed couldn't raise rates next year, even before Wednesday's market moves. He added that global deflation will remain a dominant theme and he does not expect the bank to hike its main interest rate until late 2016 or early 2017.
Chance of more QE?
Fed officials are predicted to complete the central bank's quantitative easing (QE) program at its October 29 meeting. This is the third asset-purchase program it has conducted since the global financial crash, with the Fed eager to inject liquidity into the economy and boost lending to businesses and the consumer.
Amid the turmoil of Wednesday's session, the Fed's "Beige Book" of economic conditions revealed that officials see the economy moving at a modest-to-moderate pace, with consumer spending gaining at a slight-to-moderate pace.
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Analysts at Deutsche Bank suggested that if the Fed sticks to its current guidance on policy it would be a "disaster" for risk assets. Markets have now priced out a 2015 rate hike from the Fed, according to the German investment bank.
"One wonders what probabilities you'd get that the Fed actually does QE again before it raises rates. I'm sure if you'd have suggested this a month ago many would have thought that there was more chance of Elvis being found living a relaxing retirement on the moon," Deutsche Bank's Gael Gunubu said in a note on Thursday morning.
Investors - including Gunubu - will be eagerly watching speakers from the central bank for any change in language on Thursday. Philadelphia Fed President Charles Plosser, Atlanta Fed President Dennis Lockhart, Minneapolis Fed President Narayana Kocherlakota and St. Louis Fed President James Bullard are all due to speak. While on Friday, Fed Chair Janet Yellen speaks before the "Inequality of Economic Opportunity in the United States" conference in Boston.