With the vast majority of commentators expecting the Fed to stay put in its Wednesday announcement, not to mention the market which prices in a 20% probability of a move by Yellen tomorrow, a contrarian discrepancy has emerged over the past few days: for the first time in a year, two banks – which also happen to be Fed primary dealers – have dissented with the consensus, and expect the Fed to hike tomorrow.
As Bloomberg reports, two European banks, Barclays and BNP Paribas, are betting against their crowd and the bond market by forecasting officials will raise rates Wednesday. According to Bloomberg, this is the first time more than one dealer has gone against the consensus during the week of a policy meeting since last September. Economists at both banks say traders have too steeply discounted officials’ intent to hike after the Fed has remained on hold for longer than expected.
Cited by BBG, BNP’s Laura Rosner said “there is no perfect time — there will always be some uncertainties in the data” adding that “despite a multitude of shocks through the last nine months, which have delayed the Fed, hiring has continued to be robust. There is a window of opportunity for the Fed to continue normalizing, and we think it’ll take it.”
Most disagree, and most notably the bond market itself. Futures traders are pricing in just a 20% likelihood the Fed will lift its policy rate by 0.25 percentage points, down from more than 40 percent in late August. The yield on the Treasury two-year note, the coupon security most sensitive to Fed policy expectations, was 0.78 percent as of 6:34 a.m. in New York. That’s barely above the 0.75 percent federal funds rate upper bound implied by the hike that Barclays and BNP forecast this week. The two-year yield began the year at 1.05 percent. The benchmark 10-year note yielded 1.69 percent Tuesday.
BNP wrote off any chance of a 2016 hike in February, when signs of slowing economic growth triggered volatility across global financial markets. Once the dust settled on Brexit in July, as stocks rallied and payrolls data rebounded, the bank saw September as the Fed’s best chance to resume tightening monetary policy, Rosner said.
But BNP is not alone: Barclays had forecast a rate hike at the Fed’s June meeting until a dismal May jobs report at the beginning of that month. This is the first time the bank has called for a Fed increase through the week of an FOMC meeting since December, said Rob Martin, senior U.S. economist at Barclays. “We’re not the crazy house — this is the first time we’ve been so far out of consensus on the view,” Martin said. “We’ve kept our conviction on September because we think that’s what the FOMC has communicated to us — that’s what we think the chair and the vice chairman were talking about at Jackson Hole.”
That said, the two dissenting banks admit the decision to hike will be a close call, and their forecasts may not pan out.
In general, the other primary dealers predict Fed officials won’t move in September. Instead, they’ll reiterate their intent to raise rates once in 2016, providing a clear signal for December. The trajectory of future rate hikes will likely fall. Some have, correctly, said a September rate hike would spark market chaos. Tom Porcelli at RBC Capital Markets said an increase this month would be “the mother of all surprises.” Steven Ricchiuto at Mizuho Securities USA Inc. said a hike “would be comparable to the disruption in the markets caused by last year’s ill-advised tightening.”
What Porcelli and Ricchiuto are effectively saying is that the market continue to dominate the Fed’s actions and decisions, an observation that has been accurate for the past 7 years. However, even dire warnings of a market shock aren’t enough to dissuade Rosner at BNP, and she doesn’t think the six Fed voters who appear open to a rate hike will be deterred. “Markets are betting against it because they think the Fed has chickened out for the last nine months, so why wouldn’t they do it again?” she said. “But we can attribute the Fed’s decision to pause to very specific shocks that just were coming from all directions. Now, here we are, the dust has settled, risks have diminished, and you have data that’s decent. So if the Fed is on a regimen of gradual hikes, why shouldn’t it continue?”
It “should” continue because when it comes to the Fed’s mandates, the only one that matters is to keep markets stable.
Then again, there is an outside possibility the Fed will seek to finally surprise the market, although as we showed last year, the Fed has never hiked rates when the Fed Funds rate gave less than 60% odds of a rate hike. Which means, Yellen will be looking to truly shock the market.
Or not, because moments ago that all important arbiter, the Fed’s mouthpiece itself, WSJ’s Jon Hilsenrath just called it for December, adding that “All in all, the dot plot should point toward a glacial rise in U.S. rates in the years ahead.”
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