There seems to be two large flows going on right now in the front of the curve.  I had previously mentioned our EDZ8-Z9 friend, who appears to be on the wrong side of EDZ8-Z0 flattening.   But the other development showing up on the radar is a large short in EDM8.  In the past two weeks, EDM8 OI has increased 56K, while the rest of the whites decreased 205K.  From the curve move, we can see that EDM8 position was a short.  The EDZ7-M8-Z8 fly increased 4.5bps in the past week.  That is a little strange when the Fed has signaled that they are unsure about what to do about further hikes because of the consistent low inflation prints.

This week, I thought I would take a look at the Fed pricing for the next 18 months, to see where the value is.  In this environment where the long end looks like it wants to keep rallying, we should take a look at the hikes closer to the front of the curve, all other things being equal, as the distant hikes are likely to be more-distorted by the longer-end buying.

Here are my current thoughts on the Fed meetings:

  • December 2017. Barring some kind of unexpected downturn in the data, having the Dec meeting be 90% priced seems about right.
  • March 2018. It’s a little unclear how the Fed is going to weigh inflation vs growth going forward.  A few FOMC members had indicated a preference to be more gradual, until they see some inflation signs (which we have not seen).  However, it’s not clear if the current high level of growth (~3%) will change their minds.  With the markets only pricing in only 35bps in hikes for 2018, having the March meeting take up 34% of it does seem a little high.  As a result, this isn’t my favorite meeting for a hike (relatively)…
  • June 2018. For now, my favorite relative hike play is probably June.  At under 24% if the total 2018 hikes, this seems to be reasonable value.  If we have strong growth but low inflation, I’m not sure June gets marked down that much, as the Fed could wait for more inflation.
  • Sept 2018. I have no strong view on this meeting.  On an absolute basis, 5.5bps look low.  But you would expect this to be the least popular of the quarterly Fed meetings.  Our whopping sample size of 1 says the Fed skipped Sept this year.
  • Dec 2018. We have double the whopping sample size saying the Fed has hiked every Dec meeting in this hiking cycle (2 for 2).  I would expect people to be feeling much better after the elections and going into the holidays.  If my cynicism is correct, we should get peak fiscal stimulus around election time (and the holidays), so the Dec meeting could be worth more.  But my crystal ball is fuzzy – and a year away is a looong time for the markets.
  • 2019 hikes. I suppose if you are a bear, these could look low absolutely.  But I am not feeling great about these with people buying the long end.  In addition, the Fed could be at neutral by the time 2019 rolls around.
  • Non-quarterly meetings. With less than 1.5 hikes priced into next year, it seems like a stretch to have these be worth more than 0.5-1bp.  The only wildcard could be if Powell somehow wants press conferences (and the SEP) at every meeting, so the non-quarterly meetings become more “live.”  This really seems like a stretch for someone who has pretty much been a “continuity” guy at the Fed.

I suppose the most important question right now is, where will the neutral rate be at the end of next year?  Will we keep seeing the growth to get us to the Fed’s longer run target?  Will we even need hikes in 2019?  We now know who the next Fed chair is going to be.  And he is not THAT dovish.  I think it’s probably safe to assume we may get a few hawkish Republican-friendly Governors (like Taylor, Goodfriend, etc), and on the margin could make the composition of the FOMC next year a touch hawkish.  My over/under is currently 2 hikes (maybe fractionally higher) for 2018.  That gets us close to a 2.0% FF target, and the rest will be up to the economy.

You may have noticed a few extra columns in this week’s table.  For some time now, I had been saying that the ED-FF slope looked somewhat steep, and that we should look for Fed hike value in the FFs.  Well, thanks to our EDM8 friend, we are presented with an interesting look at value when taking hawkish or dovish plays on Fed meetings…