FOMC Preview: “A Rate Cut Is Very Much In The Mix”

While the odds of a rate hike have collapsed since The Fed's decision to hike rates in the middle of an industrial and earnings recession, the odds of a rate cut remain non-negligible.

As investors await the Fed’s announcement following today’s FOMC meeting, Bloomberg's Richard Breslow they have a conundrum. No change in rates is expected. That is pretty much taken as a given. But we have to add the sub-clause: in either direction. What an interesting concept.

This is the first meeting we can remember where serious and important market participants differed so strongly on the issue of what they ought to do. It’s not just hold or raise, cut is very much in the mix.

The Fed, and then traders, are having to navigate through the existential argument whether the U.S. economy, and by extension, the global economy, are putting in place the pieces to kickstart momentum or are in a perilous negative feedback loop.

Markets are expecting to hear the Fed stress the full employment argument, with fingers crossed behind their backs. They haven’t come this far, only to stray from message weeks later at the first headwind. No one really believes, however, that they have fully abandoned the central bank put.

Futures pricing suggests the market is having nothing to do with claims of bold resolve. If they ignore recent market turmoil March could become “live” again. The Treasury short end is not at all prepared for this. Overt dovishness will wipe out rate rise expectations for the whole of 2016 and (gasp) further.

The toughest challenge will be how they handle the dollar. An inevitable consequence of a “still on-track message” will be U.S. currency strength. Exporters won’t like it. More importantly, it will weigh on oil prices and the yuan, the two main culprits cited for market (equity) turbulence.

The Fed will be looking for increasingly easy policy from other central banks to help them through this rate hike experiment. Usually I would tell them, “lots of luck.” But they may have caught their peers at just the right moment when their conflicting imperatives allow for policies that can be complimentary to each other’s needs. Rare outside of an outright crisis situation

However, the bulls remain hopeful for a "passive hawkish" Fed according to RBS strategists led by John Briggs…

U.S. rate market has potential to “react to even subtle shifts in tone, let alone language” in today’s FOMC statement.

A neutral, “passive hawkish” case would include downgraded growth language, unchanged or further improved labor market outlook, recognition and dismissal of lower market-based inflation compensation levels.

Dovish case would include mention of concern about "international developments," or a shift to "nearly balanced" from "balanced" risks, or concern about inflation expectations.

Of course we leave it to Jeffrey Gundlach to explain just what Janet and her friends need to do (and what the consequences are if they do not)…