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One Trader's FOMC Take - "A Rate Hike Is Coming And It Is Not Priced In"

A rate hike is coming. It is coming because the economy is not in crisis and zero rates are crisis rates, Bloomberg’s Richard Breslow writes. It is coming because the benefits of starting down the path to monetary policy normality are vitally important to the future health of the economy and restoring the Fed’s reaction function.

I think the Fed knows it is the right thing to do and desperately wants to reach this milestone. Yet, it wants to ensure it comes off smoothly. Hence the not so subtle hints and suggestions about the time drawing nearer.

I think September is the better choice, even if the arguments for December are reasonable. With the PBOC, BOJ and ECB all in easing mode, it actually makes it a better time to go.

The world can share the benefits and the costs. But one thing I do know, is that with all the hinting and polling and talk of trajectory, it is not priced in.

  • First, and most simply, economists can make forecasts, but investors can’t be totally sure and we are talking about the portfolio allocation choices of trillions of dollars that have been built up over a decade. There is a reason that today’s CPI number has at least the potential to move the market hard. I have yet to read an economic preview that suggests we ignore today’s FOMC minutes as irrelevant. I read two just this morning discussing the finer nuances of the word “some.” Minneapolis Fed president Kocherlakota wasn’t trying to fool anyone in an article in yesterday’s WSJ under the headline “Raising Rates Now Would Be a Mistake”
  • Another reality is that we can’t know the extent and speed of changes to interest rate differentials that will emerge, say what you will. From a systematic trading systems programming, rate changes are binary events and the finer points of 48 percent or 52 percent priced in have little meaning. On a more fundamental level, predicting inflation trajectory has not been a strong point for central banks. Remember how the ECB came to embrace QE?
  • We also have no way of knowing how liquidity-infused equity markets will react. It is a well observed phenomenon that we have been in a bad news is good news world for years. To equities a hike is very likely the polar opposite. But if there is a selloff, the Fed most likely won’t be the central bank that increases stimulus to fight it. It’s okay, stocks need to relearn how to pedal without training wheels. It’s a good thing
  • The other reality which is difficult to model a priori is that once the Fed raises rates the institutional momentum will be to push on. To go backward in rates will truly be a choice of last resort, the flip side of where we have been since the crisis. Most other central banks still find easing the path of least resistance.

And as if to confirm this perspective, Breslow notes, there is lots of movement in very mixed markets where sentiment showed itself ready to turn on a dime. What has made recent markets interesting is that moves have not been in lockstep.