Thursday, May 12, 2016

June FOMC | Last Chance of Fed to Make Room for Two Hikes This Year

The June FOMC hike is now totally priced out by the market. Even without looking at economic data since last meeting, we can confidently say there is very little chance of a hike. The chart below shows Eurodollar futures (or Fed Fund futures from 2013) implied probability of a 25bps hike on the first day of the month of FOMC meeting. The chart is not marked against dates, but rather against numbered moves since 1995.

Fed has never moved on policy at this level of expectation. Since 1995, Fed has never moved first time without at least substantial expectation priced in (not less than approx. 39% historically). And given the current FOMC board has no resemblance to ECB in 2011, the chance of a surprise is virtually zero.
However, what will be more interesting to see is if they choose to prepare markets for a July hike. If they miss July, there are only 2 meetings left this year with press conferences (and another without). Missing July will largely rule out two hikes this year, as otherwise it may contradict the promise of slow pace of hike. And if they miss preparing the markets for a July hike at this meeting, July will certainly not see a hike.
A very good take on current Fed thinking is this recent piece by Gavyn Davies on FT Blog. Given the diverging state of monetary policies across the globe and the claim of increasing data dependency, there is a risk that FOMC actions will now resemble more like the 80s and 90s in terms of direction (and even possibly size), and less like the 2000s (when all actions came in packs - series of hikes or cuts).
This means a more nimble Fed, which is great. But at the same time, FOMC also runs the risk of confusing the market.
And if they want to maintain the record as above from the chart: they will risk being held to ransom by financial markets.

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