Over the past 24 hours, market action has been framed by speeches from two Fed officials heading into today’s FOMC minutes (from the Fed’s July 26-27 meeting) release which may “reflect greater confidence in the labor market and domestic economic growth than in June.” Comments from Williams and Dudley appeared to offer contrasting views on the rate path but the market remains unconvinced that an increase is imminent, unless Yellen puts it firmly on the table when she speaks next Friday at Jackson Hole.
Today’s minutes will be more interesting than previously thought after the influential and usually relatively dovish NY Fed President Dudley’s unscheduled comments yesterday. He suggested that a September hike was “possible” and that “we’re edging closer towards the point in time where it will be appropriate to raise rates further.” He added that 10y Treasuries were “pretty low given the circumstances” and that the Fed funds futures market was underpricing rate hikes. We’ve heard this sort of thing a lot in recent years from FOMC members without much eventual action so we shouldn’t over interpret but it was inevitable that it would impact rates pricing yesterday.
Looking at markets, futures price a 51% chance of a December rate increase, up modestly from earlier this week, thanks to Dudley’s Tuesday comments.
In the minutes, market participants will watch for any discussion on labor markets, possible rate hike timing and the effectives of policy. One hour before the minutes are released, St. Louis Fed’s dove Bullard will speak in St. Louis.
Among the key items the market will be looking at:
- The key thing to look out for in the minutes will be the
language in regards to a September hike, whether it is “few”, “some” or
“many” who see it as a possibility - Low Inflation is under intense scrutiny, given it was highlighted in the rate decisions accompanying statement
- Some analysts expect the minutes to err on the hawkish side, especially after the latest commentary from Bill Dudley
- CME’s Fedwatch sees the probability of a September hike at just 18% but latest dot plot implies two hikes this year; as noted above, the latest probabiliuty of a December rate hike is just over 50%.
As a reminder, the FOMC at its July meeting voted to leave rates unchanged at 0.25%-0.50%, with George the lone dissenter. In the accompanying statement the headline that initially gained traction was that near term risks to the economic outlook have diminished. The immediate reaction was USD strength, however these moves were reversed and once the dust settled the statement was viewed as somewhat dovish. This was primarily a consequence of the FOMC highlighting persistently low inflation expectations, as such, this will take focus upon the release of the minutes.
The chart below shows the performance of various asset classes since last month’s FOMC, with crude the clear winner on USD weakness as well as renewed speculation that OPEC may proposed a production cap at next month’s informal meeting in Libya.
As RanSquawk adds, since the meeting inflation remains downbeat, the latest figures for July missing on expectations pretty much across the board, albeit marginally, so the tone of the minutes on the subject should still be pertinent. Furthermore, since the meeting productivity has suddenly come into focus, with the latest data showing three consecutive quarters of decline, the longest such streak since 1979. Usually a tier two data point, the fact that low productivity has gained traction among market participants highlights increased and ongoing concerns surrounding low US inflation. Analysts at Deutsche Bank echo this sentiment, with one of the reasons cited being real GDP growth trending downwards, which does not bode well. DB’s note reminds us that, as ever, the minutes can give an outdated picture as to Fed Members thinking vis-à-vis monetary policy.
Bullard (recently neutral) and Dudley (historically dovish) have given widely contrasting opinions as to the steepness of the rate hike path. Bullard stated that he saw one rate increase over the next few years, while Dudley kept September firmly on the table, adding that the Fed is edging closer to a hike. Economists at BofA have highlighted the disagreement among the FOMC, saying that that the divide among members may be bigger than ever before, but do go on to say that those who think September is still an option are in a minority. Futures pricing seems to agree, at only an 18% chance that the Fed will move in September. One thing to look out for in the minutes will be the language in regards to a September hike, whether it is ‘few’, ‘some’ or ‘many’ who see it as a possibility. One may look at the futures pricing and think it is most likely to be ‘few’, but the dot plot paints a different picture. The latest dot plot still sees the Fed hiking twice this year, and as many expect them to avoid rear loading in November and December — especially given the proximity of the election — commentary that futures are under-pricing a September move may be key. This is especially so given Dudley’s aforementioned comments which repudiated market’s complacency on the issue.
After shaky NFP reports in April and May, June (292K) marked something of a turnaround. Given that a strong labour market is a key pillar of the Fed’s normalization process, any commentary surrounding employment will be interesting. However, given that another positive NFP report, July (255K), was unavailable to the Fed at the time, it may garner less attention than domestic Inflation and even global macro-economic conditions. On the global macro front, any commentary in regards to Brexit may also be under the spotlight, given this was the first meeting after the referendum vote.
How will the market react?
The USD reaction will largely depend on the rhetoric the Fed use surrounding a September hike, its inflation outlook and how the overall tone of the minutes is perceived. The minutes are released against a back drop of USD weakness with EUR/USD above 1.12 and USD/JPY hovering around the key 100 level.
Stocks continue their unprecedented grind higher with all three majors printing ATH closes this week and given the strength of the upward trend in equities, it will take something surprising (perhaps overtly hawkish) from the Fed to alter the current course. Furthermore, it seems incredibly unlikely given that nothing of this nature was to be found in the rate decision statement.
Commodities, like stocks, have not been gaining ground recently as a result of central bank policy. Fresh OPEC chatter has lifted oil from those end of July lows and although the relative strength of the USD will have a short term impact, the overall sentiment in oil markets is bullish for the time being and price action is being dictated by drivers beyond US borders.
Weak data in the form of retail sales and productivity have had yields falling in the days leading up to the minutes, with the exception of yesterday (hawkish Dudley). Higher T-note prices come after real money buyers have returned to treasuries despite a month heavy in issuance, leading one to the conclusion that heading into the minutes, the complex lacks the sense of direction observed in stocks and commodities. As such, extremely choppy trade could be witnessed following the release, it’s also worth noting that volumes remain thin amid the summer time trade, potentially exacerbating any volatility. In terms of the curve, any suggestion that in fact September is very much live could see bear flattening in the curve
via http://ift.tt/2aZpPd1 Tyler Durden