At last October’s statement, the key phrase was “In determining whether it will be appropriate to raise the target range at its next meeting, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation.”  They basically told you they were about to hike at the next meeting in December 2015.  At the April 2016 meeting, the statement read, “In determining how long to maintain this target range, the Committee will assess progress–both realized and expected–toward its objectives of maximum employment and 2 percent inflation.”  Those two statements are miles apart.  If they really were bearish enough to think they may hike in June, why wouldn’t they just say so in the statement, as they did in October?  That’s all they needed to do.

This is why I said I slightly leaned towards the April minutes just being a concerted Fed jawbone for the markets… AND for the many hawks on the FOMC.  Once in a while, you have to throw them a bone – to make it seem like they belong.  So now the next battlefield is whether the data justifies a hike.  And on this, there were some wider views.  This is why I still think the bar for a Fed hike at the next meeting is high.  We need to see a very strong PCE and a strong payroll.  We also need for Brexit to be low-probability.  I was as happy as the next guy to get one or two weeks of non-crappy data.  But how can you base monetary policy on 1 month of data?!?  It’s not clear to me if the artificially high retail sales print in Japan and firm growth in Europe has given support to the theory that global growth is underway.

At the end of the day, I still think the Fed hikes at most once thru Q3.  Right now the markets have priced in almost 21bps thru Q3.  I think the risks are balanced between having a downside surprise in data and an upside surprise in data.  A downside surprise in data will basically cause a chunk of those 21 bps to evaporate.  An upside surprise, and I’m not sure to what extent that second hike thru Q3 will be priced.  This view isn’t strong enough to take a direct position, but I’m going to be looking for something in options.

The other thing is, cash libor seems to be lagging.  We got an 8.75bp selloff in EDM6 on the week, and cash libor only rose 2.63bps.  EDM6 moved roughly in line with FF, but the cash did not.  It will be interesting to see if EDM6-FF spread converges in the 3 weeks until settlement.   Otherwise, playing for the ED-FF spread to narrow makes sense.  So if you think we are capped at 1 hike and the ED-FF spread narrows, owning cheap EDU6 91 call structures makes sense.  Maybe something like EDU 91c vs 0EU 90c.  The risk is though that from the current technical support levels in EDZ7, we rally into the ECB (and the curve flattens).  I also like EDU 91-92 call 1x2s for 1.75bps… if you have other crisis protection.  But maybe I wait until June on this one.

 

[This was originally published in the May 23, 2016 issue of the CA Trades]