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Why Today's Big Fed Risk Is A "Dovish Surprise": One Trader Explains

In our preview of today's FOMC, we said there is virtually no way the Fed could surprise on the hawkish side, especially with Trump set to unveil Jay Powell as the new head of the Fed: after all, the December rate hike is over 80% priced in at this point. But what about the opposite - can the Fed surprise on the dovish side? That, according to Bloomberg macro commentator and former Lehman trader Mark Cudmore is the biggest risk today. As he writes, "growth is solid, but not spectacular. It would be a brave stretch for the committee to upgrade its outlook. The strong advance 3Q estimate was distorted by the impact of hurricanes on net exports and inventories. Far more probable is that the comments on inflation are tweaked to account for the fact that CPI is picking up slower than anticipated, while the preferred core PCE measure remains close to six-year lows."

Perhaps, but one also has to consider the possibility of a hawkish Fed surprise on Thursday, one in which Trump ignores the consensus and goes with Taylor, or Warsh. The good news here is that according to Morgan Stanley, no matter who the next Fed chair is, any pronounced market moves are to be faded.

But before we get there, we have to go through today's FOMC decision, which is why here is Cudmore's full Macro View preview of the only possible way Yellen can surprise markets:

There’s much greater potential for rates to fall than rise in reaction to the Fed decision and statement on Wednesday. 

 

The base case is for no major reaction in either direction. A December hike is already more than 80 percent priced with six weeks to run until the decision. There’s little room for a hawkish surprise to impact rates markets.

 

Fed officials won’t pre- commit, nor do they have any desire to unnecessarily lock themselves on a set path. They won’t guarantee a December rate rise.

 

The most hawkish outcome (aside from moving at this meeting) would be an improvement in the Fed’s economic outlook without a simultaneous emphasis on the failure of core personal consumption expenditure to accelerate sufficiently. But even that would lead to a climb of no more than a couple of basis points in the front end.

 

And it’s unlikely to happen. Growth is solid, but not spectacular. It would be a brave stretch for the committee to upgrade its outlook. The strong advance 3Q estimate was distorted by the impact of hurricanes on net exports and inventories.

 

Far more probable is that the comments on inflation are tweaked to account for the fact that CPI is picking up slower than anticipated, while the preferred core PCE measure remains close to six-year lows.

 

Given that there’s no press conference and no updated dot plots, a perceived downgrade of the inflation outlook could have a real impact across rates markets, and hence all other asset prices.

 

While an anticlimactic Fed decision may be a reasonable base case, it’s rare to approach such a meeting where the potential market reaction is so largely skewed in one direction.