While The Fed is confidently rising rates, the market is signalling its belief that this is a policy error. Not only are longer-dated bond yields lower but short-term money-market expectations for January now see a higher chance of a rate-cut, than a rate-hike.
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"If they do hike, watch the long-end," was the warning in September [4] for clues to a possible policy error by The Fed. As BofAML previously warned,
If the Fed does raise rates, however, that doesn’t mean the “all clear” signal will have been sounded.
To the extent investors view the hike as a policy error, a flight to quality is likely to follow with the Treasury curve bear-flattening and risk assets selling off. Even if investors don’t overtly seem to believe a rate hike is a policy error, it appears that many investors believe a rate hike will be accompanied by extremely dovish language, possibly to offset the sting of the rate hike.
As such, it is likely that the accompanying language will be dissected syllable by syllable as investors and economists try to quantify whether or not it is dovish enough. The problem with this as we see it, however, is that this line of reasoning appears to be so widely accepted that we worry about how investors will react if the actual accompanying language is interpreted as “not dovish enough.”
