FED PRICING THOUGHTS:

On the right are the Fed probabilities for the next few meetings.  I am dumbfounded that the December meeting has the lowest hike probability (other than January).  If you had 33bps to allocate among the 5 meetings on the right, I would be hard-pressed to have come up with this particular configuration.  Here are my thoughts for each meeting:

  • 150831 Fed probabilitySeptember. If the Fed hikes, you may hear news reports of a Dallas man whose head exploded.  That having been said, I suppose if we got a strong Employment Report (and not a “constructive” payroll as we’ve gotten the past few months) and China/commodities really calmed down, it’s possible.  Just possible.  I just think the risk/reward of waiting on liftoff still makes sense – especially since inflation is low and as Fischer mentioned, they are not sure what is going on right now.  If there is no hike in the September meeting, expect the 6.8bps currently in Sep to migrate towards Oct and Dec
  • October. The October meeting pricing is super-interesting – especially since it’s a non-quarterly meeting.  It is extremely unlikely for the Fed to hike in BOTH September and October.  Hiking in both would completely destroy the markets and the story they have been trying to tell about the slow pace of hikes.  Between Sept and Oct, we now have 12bps priced in.  But the cap on the sum is going to be 25bps.  As we get closer to 25 (possibly around 20), you can expect the number of bps in the Sep vs Oct meetings to cannibalize from each other (one gets higher at the expense of the other).  Also, do we need to see some nod towards an October press conference at the September meeting for October to be fully “live,” or will the markets discount October a little?  I suppose the press conference could be scheduled at the last minute, but it’s just another consideration.
  • December. The Fed SEPs shows an average of a little more than 1 hike per quarter after liftoff.  The Fed is basically saying they think they hike once a quarter.  This makes the low pricing for the Dec strange – Dec is a liftoff candidate AND Dec can also benefit from a Sept hike (since it is one quarter later).  It is my belief that if the Fed hikes, it will not be a one-and-done – because what would be the point?  Relative benchmarking with other economies probably puts us at a minimum in the 1% range (Canada at 0.5%, and the UK at 0.5%).  This is why I suggested buying the Dec meeting last week.  If the Fed skips Sep, Dec will also be paired with Oct, and the sum of the two probably will not get above 25bps (as it will be unlikely the Fed hikes in consecutive meetings to start).  But the levels are so low now that if the economy looks like it will recover, Dec should benefit.  Dec will outperform if we continue to get constructive data, but the global outlook continues to be shaky – especially with the Fed having strongly suggested a hike by year-end.  This is why the risk/reward on Dec looks so good, getting 4 to 1 – it should do well on a Sep hike, and a Sep skip.

 

Payrolls should give some clarity to the above pricing next week.  The markets are currently expecting 223K and a drop to 5.2%.  I don’t think this is enough – especially not with core PCE dropping.