Yellen’s main quote on Friday was:

“It’s appropriate, and I’ve said this in the past, I think for the Fed to gradually and cautiously increase our overnight interest rate over time and probably in the coming months, such a move would be appropriate”

In the past she has said things like “all meetings are live” (since they are data-dependent).  Just at the March press conference, she said April was live.  As we have seen, “live” could be anything non-zero.  This was really the first time she said anything like “probably in the coming months.”

So of course now, everyone is scrambling to contact their local etymologist.  I could see a reasonable mathematical equivalent of “probably” being between 51% and 99%.  Let’s just for the sake of simplicity call it 75%.  Before the post-close selloff on Friday, the FFs settled at 16.4bps for the June and July meetings (66% chance of a hike), and 21.1bps thru the September meeting (84%).  So the next obvious question is, “how many months is ‘coming months’”?  The key is that it was used in the plural, so it’s not just June.  At a minimum, it is June + July (2 months).  Could “coming” imply as many as four months to include September?  Maybe.  So to me, she wasn’t saying anything different from what was priced in the markets.  We did get a big selloff post-close, but the Gunds (Gundlach & followers) were clearly caught wrong-footed as they bet on a dovish Yellen (medium rally Thursday) followed by the puke on Friday.[1]

What seemed to be overlooked in all of this was the word “cautious.”  This was at least as important as “probably,” because this to me tells me more about the bigger picture and Yellen’s approach.  A hike here or there is not particularly relevant to that bigger picture.  We are probably about 3-4 hikes (just a guess) below most people’s models of the current “neutral” funds rate.  So a slow removal of the accommodation is to be expected.  Maybe not after just one month of decent data, but by September (and possibly July) we could have enough firm data.  “Gradual” is a word that has been used very frequently with respect to Fed policy.  The word “cautious” has not been used as frequently.  For example, in the last FOMC minutes, the word “gradually” (in the context of Fed policy) was used six times, while the word “cautious” was only used once.  Yellen is going to be cautious!

Assuming we just get the consensus prints on data next week, I still don’t see a June hike.  One month of data is not adequate in my opinion.  We also have Brexit that some Fed members seem to be unsure about.  This is why Yellen said “in the coming months.”  The “probable” scenario for me right now would be a language change to the June statement implying a July hike.  But we are data-dependent.  So let’s see what the data holds in store for us next week.  I’m a little surprised the consensus for payrolls is only 158K.  We don’t have a lot at the front of the curve, so let’s see what happens.

[1] http://www.bloomberg.com/news/articles/2016-05-27/gundlach-says-yellen-speech-to-be-dovish-as-treasury-bid-soars

[This was originally published in the May 30, 2016 issue of the CA Trades newsletter]