With stocks gapping higher at the open for a third day, only to drift lower, the reason may be that Wall Street, which has priced in negligible odds of a rate hike – at only 22% – is suddenly sweating.
Indeed, with just one hour left until the Fed’s decision and with just 4 of 102 economists in Bloomberg survey predicting Fed will raise rates today, the last minute mutual assured destruction warnings have come out, with strategists cautioning that a surprise increase would lead to a sharp drop in risk assets, and trigger large moves across the curve which would flatten dramatically, while others make case for steepening and wider credit spreads.
In short, if Yellen does for some reason surprise – and remember that the Fed has almost never hiked when the market implied probability was below 70%, nobody is prepared.
Here, courtesy of Bloomberg, is the gaggle of sellsiders uttering their last minute warnings just in case Yellen does decide to turn against Wall Street:
Priya Misra, TD
- “A hike would be a huge surprise. I think risk assets fall a lot (>2% correction), USD goes up and rates rise, led by the front end”
Dominic Konstam, Deutsche Bank
- “Big shock. Rates sell off initially along with risk assets, but I think curve would stabilize/flatten from long end;” view hike “as a policy error, unless they also crushed the long-term dots”
Jay Barry, JPMorgan
- “A surprise tightening would reprice front-end yields sharply higher. We also think yields at the long end would be relatively unaffected and the curve would flatten, as this move would likely have little impact on the market’s view of how much the Fed will tighten over time”
Jabaz Mathai, Citigroup
- “That would be a curve flattener — at least initially. There is a significant impact on risk assets, with the dollar rising, equities selling off, etc. But if they do increase and indicate that they’re done for the near term, probably not a very severe reaction if December gets priced out”
Shyam Rajan, BofAML
- “Not our baseline call, but we believe any hawkish Fed surprise would be a curve flattener and lower breakevens”
Richard Gilhooly, CIBC
- “Curve would collapse flatter, maybe by +10bp on 5s30s; short rates up, long rates down”
Ian Lyngen, independent
- “It would be a dramatic flattener initially led by the 2-year sector pressing higher in yields, but the 5-year would end the underperformer on the day as the market increases the terminal rate level and timing assumptions”
David Keeble, Credit Agricole
- “I actually think that the curve would bear-steepen. I would assume a 10bp rise in the 2Y yield and a couple of bp more for the 10Y. In part this is because the 2-5Y and 2-10Y spreads are scaled versions of the slope of the money markets. Right now, the money markets are expecting close to nothing for the next couple of years. A rate hike today means that we all need to tweak our assumed Fed reaction functions to the data”
Aaron Kohli, BMO
- “I’d expect credit spreads to continue to get slammed and to see a lot of pressure on funding from banks. The risk-off would be palpable and cause more dislocations on the front-end especially since markets are not expecting it in the least”… “This kind of surprise should cause a rapid tightening in financial conditions in the immediate aftermath, with the risk that leveraged borrowers would face a steeper adjustment path to higher rates”
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