One of the things about the “gradual and communicative” Fed is that they pretty much tell us most of the important things we need to know well in advance.  No one said anything about a hike (even the hawks) so the odds of a hike at the September meeting is basically “zero.”  They have also communicated for the past two meetings that tapering is coming, so the odds of the Fed not announcing the taper at this next meeting is also basically “zero.”  I suppose there could be some question about when tapering would start.  My “pick a date out of the air” guess would be October 1.  But I know nothing.  I just think the Fed is itching to normalize the balance sheet, and reinvesting a few less securities does not seem so radical a change that it can’t take effect in a short period of time.

Tapering should be 99+% priced going in.  However, it is my theory that it could take some markets some time to get used to trading without the Fed reinvesting tailwind.  So I think it’s important to make some room to add to reflation trades, if we get any kind of noticeable “buy on the news” bounce in fixed income.  Over the next year after tapering, I think we should get less favorable bullish price action than we’ve seen in previous years.  But it could take some time for the markets to adjust.

The most interesting part of the meeting for me are the dots.  Considering the markets have pretty much ignored the dots for most of the year, this may seem like a silly thing to say.  However, since the Fed eventually makes the decisions on rates, understanding what they think will be important in how the curve is priced.  In particular, I’ll be looking at three things:

The 2017 dots.  For simplicity, I’m going to assume no one is calling for a Sept or Nov hike.  To review, at the June meeting we had 4 members call for 2 more hikes this year (“blind hawks”), 8 people call for 1 more hike (“light hawks/moderates”) and 4 people call for 0 hikes (“doves”).  I think it’s reasonable to assume the blind hawks will now go down to 1 hike this year.  It’s also reasonable to ignore these people for being out-of-touch.  So we are left with 12 dots that matter.  We could probably take out Bullard’s dot and a few more hawkish dots, but I think the bottom 12 are a reasonable representation of the core Fed.  The question then comes down to how many of the previous 1 hike folks go down to 0?  My over/under is 2.5, bringing us to 6.5-5.5 (for 0 hikes vs 1 hike).  We would also lose Fischer after this meeting, and I would have thought he was most likely in the “1 hike” camp.  I think the Fed should skip another hike this year (assuming the data stays in-line), but the Fed can be sticky with their dot plots.  We’ve had no inflation, Q3 GDP is on a lower trajectory, and retail sales have not been great (except 2 months ago).  Even if they think they are going to hike, they probably aren’t factoring in the debt/budget deadline a few days later (which on the margin raises the hurdle for a hike), so I think the markets will price the Dec meeting less than the Fed.  We will have a lot of data noise, which could make the meeting a little trickier to guess.

The 2018 dots.  The Fed dots have been pricing in a little over three hikes for some time now.  I do not expect that to change.  So it’s a little crazy that the markets caused EDZ8-Z9 to go below 25bps.  If the longer end dots do come in, I would expect the 2019 dots to take most of the hit.  For me, if the Fed still believes in 3 hikes next year, I am going to look for dips to put on some bearish trades.

The Long Run FF dots.  A few weeks ago, I suggested that the 30 year rate could be roughly capped by the Fed’s long run FF projections.  We know Kaplan is lowering his dot, to around 2.625.  Will Brainard/Kashkari do the same?  Is Dudley going to lower his long run dot, if he thinks there are structural forces keeping inflation low?  How about the other members of the FOMC?  I’m not sure I saw anything in the past three months to think the longer term rate should be noticeably lower (other than the markets buying the long end like mad).  But inflation has been low for a while and we have had no wage pressure, despite the constructive growth.  I think part of the very long end flattening on the selloff last week is the expectation that the Fed dots will move lower.  My over/under is that the longer run dots will drop about 10bps (as a mean), but possibly more as a median.  It would only take 2 of the 3.0% dots to move down to 2.75 for the median to move 25bps (this is why I hate the median as a measure).  I think some of this could be priced in.  But really, if the markets can so blatantly disregard the Fed’s 2018 dots, I’m not sure how much the long run dots should be worth.