- After the anticipation of the previous meeting, markets focus on the statement and whether the FOMC still see December as a date for lift-off
- The vast majority expect the Fed to keep the Fed Fund Rate on hold at 0.00-0.25%, however there is a minimal outside bet (~4%) that the Fed will hike rates by between 15-25bps
EXPECTATIONS
Probability of hike as priced in by futures**
October: 4.0%
December: 32.8%
January: 40.9%
CME Fed Watch**
October: 5%
December: 30%
January: 40%
**Accurate as of 1700GMT Tuesday 27th October
Rate
Lower Bound
Expectation: 0.00%
Current Rate: 0.00%
Upper Bound
Expectation: 0.25%
Current Rate: 0.25%
OVERVIEW
Following last month’s highly anticipated decision, October’s is markedly less so, with expectations shifting downward following the meeting to now offer a large consensus that the central bank will leave rates unchanged. There currently remains a minimal outside bet (markets pricing in a ~4% probability of a hike), however, remarks from Fed officials over the past couple of months have been non-committal while largely keeping in-line with their previous opinions. Yet, some of the more dovish members have stated their preference for a delay until next year. Furthermore, market participants know that the FOMC will not want to surprise the market and add to the global instability, it is therefore likely that the Fed will be much more informative and there will be minimal uncertainty over when a hike will occur. Also of note, Fed Chair Yellen did state that the FOMC will call an emergency meeting if the Fed saw a viable opportunity of increasing interest rates.
Many analysts have stated that it is exceedingly unlikely that the Fed will hike rates on Wednesday given the relatively poor US data in recent weeks with US nonfarm payrolls only averaging 139K over the past two months. Due to no press conference following the decision, focus will be fixed firmly on the statement and for any changes. Participants state that there is likely to be minimal change to the statement with investors looking for whether December is “affirmed” as a potential date for rate lift-off. Focus will also surround any change in tone towards inflation and jobs growth given the recent poor performances in NFP. Of note, analysts expect the Fed to delay a hike due to wanting to make sure that the recent lull in economic data is not sustained, that job gains do not continue to soften and inflation pressures are continuing to firm. In terms of the inflation, the latest reading marked the 2nd straight monthly fall due to lower gasoline prices, yet, core CPI was better than expected which could be viewed positively by the Fed.
Central banks were in focus last week, with the ECB adopting a dovish tone following their rate decision, with President Draghi stating that they will look again at the amount of stimulus required in December adding that QE will continue to Sept 2016 and could be extended if necessary. Furthermore, the PBoC lowered their 1 year lending rate by 25bps from 4.60% to 4.35%, 1 year deposit rate by 25bps from 1.75% to 1.5% and RRR by 50bps from 18.0% to 17.5%. This has stoked speculation amongst analysts that this is positive for the Fed as it shows that economic weakness in being addressed and that less of the pressure now resides with the FOMC. However, it is also being touted as potentially negative given that it shows central banks are having to reduce rates and discuss further easing measures due to the weakness in global markets. Furthermore, the potentially stronger USD is likely to impact on US companies and cause additional pressure on inflation.
PROJECTIONS
Projections from September:
- Fed median Fed Funds Rate seen at 0.375% at 2015-end, at 1.375% at 2016-end, and 2.625% 2017-end; 13 officials would rather see rate lift-off this year instead of in 2016. Longer run rate forecasts. 3.50%
- Estimates 2015 GDP growth of between 2.0%-2.3%, unemployment rate at 5.0%-5.1%, and core inflation of 1.3%-1.4%.
MARKET REACTION
Markets have the potential to see a fairly muted reaction given that the October meeting has almost been completely disregarded as a potential meeting for rate lift-off and that minimal alterations are expected in the statement. However, if the Fed were to hike rates, we are likely to experience larger price swings due to the ~4% chance of a hike that is currently priced in to FFR futures. Additionally, if the statement is quite aggressive towards reaffirming December while stating that the recent lull in economic activity is minimal and short term it is likely to be interpreted as more hawkish. As such we are likely to see immediate strength in the USD-index alongside the US yield curve flattening. However, we are likely to see minimal reaction if rates are kept on hold, yet, if December is ruled out as a date for rate lift-off this could be interpreted as more dovish, pushing rate hike expectations further into 2016, and cause weakness in the USD-index alongside curve steepening. Over the past few months US equities have seen a choppy reaction to Fed policy meetings given that a hawkish communication is largely seen as negative for stocks given tighter conditions, however this stance implies a strengthening in economic conditions which can be interpreted as stocks positive.