Now that we’ve had some Fed shenanigans and the odds on various meetings have changed, we should do an analysis of the Fed probabilities for the next 15 months.  There are a number of notable changes since the last time we looked at this.

  1. The non-quarterly meetings got killed. I mentioned two weeks ago that the Fed may be reluctant to hike at a non-quarterly meeting, based on how much they were in a rush to hike in March.  So this can be understandable.  Remember less than three months ago, when our FFX friend jacked up the non-quarterly meeting probabilities?  I can’t believe FFV6-X6 spread was as high as 6bps (currently 2bps).  At the time, my WAG model[1] indicated that the non-quarterlies should be worth about 33% of a quarterly meeting.  After we’ve seen that the FOMC may be avoiding non-quarterly meetings like my oldest son avoids veggies, my guess would be closer to 20%.  Non-quarterly meetings are currently 15% of quarterly meetings.  So we should look at cheap  non-quarterly meetings to fit our view.  Calendar configuration becomes really important.  We should do a “draft”-style analysis of the non-quarterly meetings to weigh the various considerations [see next section].
  2. Why is May only 0.3bps?!? I am shocked that with two PCE inflation prints and one Payroll, the markets are this confident.  Even if we don’t get a tail event, if we just come a little on the high side, are you really going to be comfortable not having any protection?  We just saw what happened to March.  I can see that the final French election is on May 7.  Maybe we get enough market nervousness that the Fed pauses.  Or not.  It’s a cute story – the French election that will bring down the world.    We just saw someone bigger leave (UK), and it ended up not being a big deal.  The Fed saw this too.  I want to see some consistency… the German election is September 24.  Granted, the German election may not topple the EU, but if you want to make up cute narratives, why not?
  3. June and Sept are both slightly over 50%. Considering how strong the data has been, it’s hard to argue with this.  And I am thinking some economic data could be pulled forward because of trade fears.  Getting back to French election consistency, if Le Pen is 20% to win, is this already discounted in the June meeting (so that it is as much as 15.8bps priced without Le Pen)?  I would think so.
  4. Dec 2017 meeting is no longer the highest meeting on the board. It’s strange that the data got stronger and the Dec meeting looks less attractive.  Wat?  FFX7-F8 spread was as high as 14 (on two separate occasions) and now it is 10 (3 mo low).  So the market’s Hatzius[2] logic is that the economy is going to be so strong that the hikes get moved up, but they are less likely to hike in Dec, when we should get Trump stimulus.  My head hurts.  They did hike the past two Decembers, did they not?  Some of the new Flip Trades I suggested capitalize on this.
  5. March 2018 is the first meeting with a potentially new Fed chair. I still think it is not in Trump’s best interests to select a hawkish Fed chair.  But the names will start circulating later this year, and nothing “additional” seems to be currently priced.  I think owning the first few meetings of the next Fed chair (possibly vs other meetings) is good value.
  6. May 2018 is the first non-quarterly meeting with a potentially new Fed chair. A Yellen Fed may not want to hike in consecutive meetings.  But how about a Taylor Fed?  Again, I doubt Trump is going to nominate someone who is going to jack up rates, but this seems to be the cute story people in the markets like to tell.  We should anticipate it.

We should think more about the above and look for opportunities to get some good risk/reward plays on.  I have some preliminary thoughts in the Trade Thoughts section.

[1] Wild-Assed Guessing.

[2] Jan Hatzius (Goldman) moved up his Fed hike calls last week from Sept and Dec to June and Sept.