160828 Fed pricingIt’s been a while since we looked at the Fed probabilities.  And now that the Fed looks like they may be on the verge of doing something, we should take a closer look at the meetings.

  • September.  Friday’s price action was interesting because when Yellen gave no specific indication of time-frame (as some may have thought was necessary for the September hike), FFV rallied 1.5bps.  Then when Fischer suggested that Yellen’s comments were consistent with the possibility of a September hike and as many as two rate hikes this year, FFV sold off as much as 5bps off the intraday highs.  The September meeting is almost the highest-priced meeting on the board.  We are data-dependent, and I have no idea how the numbers will come out next week.  At this point, a hike seems somewhat reasonable (assuming firm PCE and payrolls).  The main thing preventing me from being on-board with the September hike story is that libor is high and there is some market uncertainty with how the new money fund regulations will play out.  It would be terrible if an early hike caused more turbulence in this market, since a hike could cause 3 month libor to be over 1.00%.  I think libor-FF “should” be discussed at the next meeting (so don’t be surprised if it shows up in the minutes).  A reasonable compromise seems to be to put in stronger language in the Fed statement (a la last October) for a hike later in the year: “In determining whether it will be appropriate to raise the target range at its next meeting” or “at a meeting later this year.”
  • November.  Earlier in the year, I did not think a Nov hike was remotely likely.  However, because of the new money rules that go into effect in October, it has come into play.  Funny how something always comes up to bring the non-quarterly meetings back into play.
  • December.  I still think this is the highest probability hike candidate.  Sept could cannibalize Dec to some folks, who may think there is only one hike this year.  While there could be some cannibalism between Sept, Nov and Dec[1], a Sept hike still allows for a Dec hike with 3 more months of data.  It is not out-of-the-question for the data to surprise to the upside the rest of the year.
  • February.  It is not clear how the Feb meeting could come into play right now.  But as we’ve seen with the July and Nov meetings, you can pretty much make up a “reasonable” story for ANY non-quarterly meeting a few months out.  So Feb, May and July look like reasonable flips to me (as long as you have some ease protection).

Taking a step back and looking at the bigger picture, there are 19bps of hikes priced into the end of the year.  The reasonable range to me based on what we know now is between 0.75 to 1.0 hikes (factoring in the current high libor), so we are at the lower end of what seems “reasonable” to me.  As for the 2017 quarterly meetings, they still seem a little low at 4 to 1, so I like trying to accumulate this exposure through things like buying year flies and buying spreads on dips.

[1] And definitely between Nov and Dec, as I do not see the Fed hiking in consecutive meetings.