Today [Wednesday], the Fed releases minutes from the September 20/21 FOMC meeting. We already know there were three dissenters at that meeting in favor of an immediate hike, and there were loud grumbles from large market participants like Bill Gross after the Fed kept rates unchanged. However, what is certain is that prior to the Fed meeting, the market was not pricing substantial odds of a hike. In fact, the contract that would clearly and instantly react to a hike in the Fed Fund target, October Fed Funds (FFV6), was priced at 9956.5 just prior to the meeting. On a hike it would have moved to 9935.5. On no move to 9960.5. So at 9956.5 the odds of a hike (ignoring a couple of small technical details) would have been around 20%. In fact, since the meeting, the contract has been pegged at 9960.5. The point is, this Fed is cautious, and not really prone to ‘surprising’ the market. In other words, the Fed doesn’t want to be blamed for adverse market moves on a hike that hasn’t already been accepted by the market in terms of pricing.
So where are we now? FFX7 (The November contract), settled on Tuesday at 9958.5. Therefore the market is virtually ignoring the possibility of a move at the November FOMC which is just prior to the election. The subsequent meeting is on December 14. There are a couple of ways to determine odds of a hike at that meeting. The easiest is probably just to use the January 2017 contract (FFF7) which settled at 9943.0. Again, ignoring a couple of technical details having to do with the Fed Effective rate at the end of the year, at a price of 9943, we can say that the contract is pricing around 70% odds of a hike in December. So, the market is ‘ready’ for a hike.
Obviously, a big slide in economic data could change the odds, and we do have two employment reports prior to the meeting. However, the outcome of the presidential election is not very likely to change the mind of the Fed or the market. On Friday, Chair Yellen is slated to speak at the Boston Fed’s Conference, entitled “The Elusive ‘Great’ Recovery; Causes and Implications for Future Business Cycle Dynamics.”
At that time, Yellen can easily solidify the gradual path to normalization, though her comments after the Jackson Hole conference left many convinced that September was on the table. The takeaway point is that the market is ready for a hike, and has also accepted the Fed’s narrative of a lower long term equilibrium short term rate (terminal rate). At this point the Fed would ‘shock’ the market by standing pat in December. One final point, which I mentioned in my post last week: The crude oil market continues to show strength as Putin indicated that Russia may freeze or curtail production. Year over year comparisons in the price of energy will surely tend to push inflation data higher over coming months, giving the Fed plenty of cover to hike.
Alex Manzara
