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Fed Signals December Hike is Possible, Yes, Likely? Maybe

Janet Yellen and William Dudley are trying their best to convince the markets that a December increase in the Fed Funds rate is, as the Fed Chair said Wednesday in Washington, a "live possibility."  

Credit markets have responded smartly to the assertions of Chair Yellen and New York Fed President Dudley. The yield on the 2-year generic Treasury closed at 0.8116 on Wednesday, the highest since April 11th, though not by much as it closed at 0.8108 percent on September 16th.  The return has soared from 0.5487 percent on October 14th.The return on the 10-year has climbed from 1.9718 percent on the 14th to 2.2268 percent today.  

Is the Fed setting the market up for another disappointment?

When the Fed declined to increase its benchmark rate at the October 28th meeting despite having fomented expectations that a hike was likely, markets immediately went the other way on speculation, pushing the forecast for the initial hike off into the first quarter of next year. 

Neither the Fed Chair nor the New York President seem to care much about the inherent tendency of markets to speculate on the future course of central bank policy.

If Fed officials pointedly say that a hike is a possibility, traders assume that they mean probability and trade accordingly. No amount of reference to 'data dependency' will alter the direction of the market. Nor will any data short of catastrophic change positioning. Poor data between now and the December FOMC meeting will be considered a temporary aberration. 

When the Fed does begin to raise rates it has said that further hikes will be extremely gradual. Accommodation is here to stay, at least by historical interest rate standards. There will be no rush higher in rates as credit markets adjust to the first tightening cycle in over a decade.

The Fed governors may feel confident that the U.S. economy will perform as they expect for the next two months enabling a December increase. But the world is an uncertain place. Any number of events could trump their expectations and damage the fragile world economy. The FOMC has already demonstrated its concern for global economic conditions. 

If, instead of telegraphing its opinions, the Fed had said little in the next five weeks letting the data speak for itself and then raised rates on October 16th, the market result would be no different and no more volatile than that obtained by letting the markets know aforetime.  

There is however one large potential difference.

The Fed would have saved itself the embarrassment of having misjudged events and policy yet again. Why the Fed takes this unnecessary risk with its credibility is a mystery.  

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Joseph Trevisani

Chief Market Strategist

WorldWideMarkets Online Trading

Charts: Bloomberg

 



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