Earlier this week, Citi's head of G10 FX strat Steven Englander conducted a survey among 350 participants (40% from the leveraged community, 21% real money, 23% Citi colleagues, 5% corporate and a smattering of central bankers and others), asking them what they expect from Janet Yellen's Jackson Hole speech. According to a vast majority, or 85% of the respondents, Yellen will lean toward one 2016 rate hike with hiking risk “overwhelmingly” in December even as September hiking risk is seen as “modestly underpriced."
He also writes that about 2/3rds expect an indication of a December hike in the speech, "with many more seeing it in abroad dovish context, rather than hawkish", however respondents see market as expecting just over 50% probability that 2016 hike is indicated in speech. He notes that almost 50% see higher EM as the outcome, but much more split on G10 outcomes.
Englander points out that if she does deliver a dovish long-term message, but signals one 2016 hike, investors expect to:
- Buy EM
- Buy S&P
- Sell 2s
- A couple of respondents would buy EM debt or other parts of the US yield curve
Less than 10% think Yellen will endorse a higher inflation/nominal GDP/price level target, but 25% think she will refer to inflation asymmetry. Remaining 2/3rd expect her to stick to 2%
29% think they will change their targets in the next two years (but not necessarily signaled at Jackson Hole); 50% think the targets will change only if there is a recession
With consensus so pronounced, there is substantial risk of pain trades. This is what they are:
- An indication of a September hike – she may try and spin as dovish long-term but it remains so unexpected that it will be hard for her to be convincing and market will sell off. Pain could be mitigated if she indicated only one hike in 2016.
- Neutral, explicitly dovish or very non-committal on hikes. Investors would see themselves as underweight risk.
The expectation of short-term dovish and long term hawkish indicate that investors are looking to buy on dips if she makes a December hike even more live (although 65% chance of hike priced for December looks pretty live to me already). The risk to this approach is if liquidity is poor and the short term selling leads to a bigger market sell-off, or if buying sentiment becomes so strong that prices move faster than investors are able to hit the buy button.
There is a very strong consensus (85%) that Yellen (85%) expects to do one hike this year, and most expect then next Fed move to be a hike (77%). About 2/3rds are looking for an explicit hiking signal at Jackson Hole. I see these odds as too high – they may hike if everything goes perfectly Yellen. But if you take out September, the benefit from having an explicit lean seems low.
My expectation is that she signals that she is open to hiking but needs to see more data and wants to see the economy running hot. I also think she feels that strong demand growth will improve productivity (more investment) and participation (higher wages induce labor supply), so she will accept a hike if things are going really well and the hike is innocuous, but not if she still feels they are failing on demand side. This will come across as dovish in my view.
1. The Fed’s next move
The ultra-dovish tail has practically disappeared. Since early January I have been struck by how many clients and colleagues were convinced that recession risk was high and that the next move was an ease. This no recession view means that USD in G5, and equities are vulnerable if the economy turns south. Long term yields have a ways to move down if data soften.
2. Yellen at JH
Investors on an individual basis think she will signal one 2016 hike, but they think the market as a whole is more dovish than they are. The big difference is between personal and market view on whether she will signal 2016. This may mean that investors overestimate the short term negative reaction if she signals one 2016 hike. Note that there is an overwhelming view that Yellen wants to hike this year at least once (88%). This is why I think if she signals that she is not yet convinced, risk buying will be hand over fist.
3. Buy on dips – FX and first trades
The first chart is the unconditional expectation; the second if she delivers the consensus one 2016 hike, plus dovish. Buy EM stands out in both, but market much more split (and less excited) on G5. I assume that AUD and NZD will trade with EM. Note desire to buy 10s, sell 2s and buy S&P in addition if she delivers the dovish hike goods. I think many investors just want to be sure that she does not surprise on the hawkish side and then will proceed to buy more risk.
4. Changing targets – not so fast
Any sign that she is leaning to a target shift would be massively dovish. She has already talked about running hot and inflation asymmetry – if she makes a big emphasis on this it would probably be dovish as well, effectively in market view pushing the inflation target closer to 2.5% than 2%, even if she doesn’t explicitly say so. That is a "Feddish" compromise – keep the old target in a formal sense but wink and nod to a higher effective target, with a degree of plausible deniability. Casual reference is neutral, but making a big deal about risk management is dovish. Note that Fischer emphasized how close they are to the existing targets, but his hawkishness (which I share normatively) sounds almost quaint these days. That said, if the economy hits a pot hole – hello target change.