The paradox continues: on one hand stocks continue to anticipate a reflating economy, with S&P futures hitting a new all time high overnight; on the other hand, the weaker dollar and especially Treasury yields are increasingly worried that today's rate hike, the 4th in the past decade, will be another policy error, leading to more curve flattening and eventually a deflationary outcome.
And while there is little doubt Yellen will hike today as Goldman, and consensus, expect, the question is what the future pace of rate hikes will look like and whether the recent disappointing CPI prints will mean and "one and done" for the rest of the year from the Fed. While there is some possibility of an unexpectedly hawkish statement from the FOMC, especially if the Fed is worried about an asset price bubble, it is far more likely that today's announcement will be yet another "dovish hike", which is what SocGen's Kit Juckes previews in his latest overnight note.
Here is SocGen with "The day of the dovish hike?"
At 2.21%, US 10year yields are firmly in the low end of the 2017 range, while at 1.35%, 2s are very close to the highs. The Treasury market is convinced the Fed will hike today, but not convinced about the longer term. Yesterday's NFIB small business survey was just one of the data points to underline why the market is so perplexed. The response on ‘jobs hard to fill' is at 34%, the highest level since December 2000. But we can all see the lack of wage growth, which used, once upon a time, to correlate pretty well with this survey. Hence the call from the likes of ex-Minneapolis Fed head Naranya Kocherlakota for the Fed's inflation target to be raised; at the same time as 10year breakeven inflation rates on TIIPs fall to 1.78%, their lowest level since 8 November.
The FOMC’s response is likely to be a ‘dovish hike’ and that’s priced in, to a large degree. Uncertain about how much slack there is in the economy or the labour market, FOCM members are inclined to want to ‘normalise’ rates while they have the chance, but they seem very pragmatic about the longer-term outlook.
So more likely to raise rates now, without overlay hawkish commentary, and then lay the groundwork for another hike in the autumn if markets don’t take fright in the weeks ahead. That could leave yields in their range, the hunt for carry intact. Obviously, since this is to some degree what the market expects, the converse is also true – a ‘hawkish hike’ would come as a big surprise and unsettle higher-yielding currencies.