Here are the nuggets I thought were interesting from the FOMC meeting:
- The FOMC went to a balanced assessment of risks and said that “the case for an increase in the Federal funds rate has strengthened.” They stopped short of giving a time-frame however. What we have is a more forceful version of the status quo, which is data-dependency – “to wait for further evidence of continued progress toward its objectives.”
- The million dollar question is, what constitutes “evidence of continued progress.” In my view, I think it’s only about 125K in payrolls (all other things being equal). I know there is more than just one number (payrolls) involved in assessing the economy – I’m just trying to grossly simplify the discussion. It will probably take over 200K to get a November hike. Regardless of what they do, you know Trump is going to be crying “foul.” If we were to average under 100K for the three payrolls leading up to the December meeting, a Dec hike may be unlikely. If you assume that the payrolls are some kind of normal distribution, it’s “likely” the Fed hikes, because I would guess off the top of my head that the mean will be like 150K per month. The belly of the probability curve is usually underpriced. I like to play the percentages.
- The markets are pricing in only 14bps of hikes by year-end. This seems a little low. I suppose it’s possible the weak data we have seen this month is the start of something bigger. Or it could just be one bad month of data, as we got many times before. I think if we get another pop in EDs, I like looking for good risk/reward ways of getting short, because…
- Only three FOMC members think we don’t hike this year. As we have seen over the years, the dots are basically crap – EXCEPT when the dots are nearer term. As an extreme example, if all but three FOMC members thought they would hike at a current meeting, well, then they are definitely hiking! If all but three members think they are hiking at the next meeting, barring some catastrophic data, they are probably If all but three members thought the FF rate will be above 1.75% by the end of 2018, well, that is much more likely to be subject to error, since it is so far away. I like to play the percentages.
- Three dissents means they are two dissents from being deadlocked on a hike and three voters from an actual hike. We don’t need that many more members to switch to get a hike. Since Rosengren, George and Mester were probably all in the “2-3 hikes in the last three meetings of 2016” camp (they are three of the four high dots), they will almost certainly still think we need a hike this year. There are probably two voters in the “no hike in 2016” camp (Brainard and Tarullo) among the three “no-hike” dots. Everyone else seems like fair game to jump on the “hike” bandwagon. Yellen, Dudley, Bullard, Fischer, and Powell have all sounded like they didn’t mind a 2016 hike at some point in recent months. In fact, they may only need Yellen’s vote on a hike because that alone may be enough to drag along two other votes somewhere to get a majority. The bar for a hike is low.
- Only three FOMC members think we don’t hike twice in 2017. Using my advanced math, that means the year spreads around 2017 should be about 50 bps. EDZ6-Z7 is only 15.5 bps. We do have Article 50 next year that could lead to another Brexit-related squeeze in the markets. But I think the markets should be less panicky than last time. Besides, Article 50 could possibly over a year away (if at all), so that should not be an immediate near-term concern. Trying to play for that with year spreads as low as they are is probably beating a dead horse. And with the Fed potentially hiking more than once before then makes the timing unattractive. So buying cheap near-term calendar spreads on dips with some ease protection makes sense from a risk-reward perspective.