The Fed meeting is in 2.5 weeks, and right now, 6.4bps are priced in.  We have a little more data (Retail Sales, CPI, etc) before the meeting, but the picture probably won’t change dramatically for the FOMC meeting.  I thought I would go over the pros and cons of hiking in September.

PROS:

  • Payrolls have averaged 232K
  • Q3 GDP is running close to 3%
  • Some core inflation measures are elevated (CPI, Cleveland CPI)
  • Removes excess accommodation
  • Removes some asset price bubble risk
  • Get it over with
  • Restores some Fed credibility

CONS:

  • Even with a 3% Q3 GDP, we are only at 1.6% annualized for the year.
  • There is still labor market slack (participation, part-timers, etc.)
  • Wages are still low
  • Overall inflation is low
  • Oil has declined recently, putting downward pressure on future inflation
  • There is no reason to think we will get sustained inflation against the current global backdrop
  • Global weakness is still a risk
  • The markets are not pricing it in, and there this could cause more volatility
  • 3 month libor at 83.5bps is acting like the Fed has already hiked this year
  • The commercial paper market could be under stress in the weeks leading up to October 14. A Fed hike will exacerbate the short-end problem at a potentially volatile period.

Overall, the 3 to 1 current market odds of a hike in September seems fair.  If I were on the FOMC, I think a skip in September with stronger language for a hike later in the year (not necessarily the next meeting) makes the most sense for the current environment.  It pretty much accomplishes everything they need to – it buys them more time, while getting some of the benefits of hiking.  This seems like a reasonable compromise between the doves and the hawks.

It seems to me that the Nov meeting at just “1” bp (FFV-X settled at 1.5, but FFV has 3 month-end days) could be a reasonable play for the “no September hike, but stronger language” play.  This could be a reasonable “flip,” as it’s hard to see this going much lower before the Sept meeting (all other things being equal).  I realize the markets aren’t going to be on board for a pre-election hike.  And I still think a Dec hike still makes the most sense.  But Yellen herself said all meetings are live, and if it wasn’t for the election, the Nov meeting would be much higher priced.  It’s not as if monetary policy will kick in in less than 1 week.  What’s the worst that can happen with FFV-X (barring an ease)?  The FFV-X spread goes to 1, and we get unbelievable odds going into the Fed meeting?  That’s not so terrible.  The “zero” value of FFV-X will probably be around 0.6.  Consider adding this to the Flip List mix.