A Very Brief FOMC Primer

Last Week This Morning

• 10 Year Treasury up to 2.90% from last week’s low of 2.82%
  • German bund drifted lower to 0.25%
• 2 Year Treasury ticked up to 2.74%
• LIBOR up to 2.455%
  • If LIBOR behaves like it did after last year’s hike, it should breach 2.50% next week, level off in the mid 2.50%’s, and then sit tight until the next hike is priced within 30 days (March?)
• Chinese industrial and retail data came in weaker than expected
• ECB lowered forecast for GDP and inflation

FOMC Meeting – Tuesday and Wednesday

The market has a 72% probability of a rate hike priced in to Wednesday’s announcement.  We think it’s more like 90%, but can’t blame the market for pricing in some possibility of a pause.

More likely, we expect a dovish hike.  This could actually make the market more happy than a pause because the market is forward looking.  To illustrate this point, ask yourself which would be better…a pause with a commitment for 3 hikes next year?   Or a hike with reduction in future hikes?

We expect the Fed to reduce the number of hikes next year from three to two, which would put LIBOR around 3.00% at year end.  They will also likely lower the long end (2020 and beyond) to 3.0% – 3.25%.

We expect lots of language about data-dependence.  And of course, some sort of reference about rates being close to “neutral” to undo some of the damage from that infamous October 3^rd statement.

These sort of signals would be welcomed by the market, evidence that the Fed is not tone deaf to developments.  Stocks would likely rally and the T10 could push higher.

But if Powell mishandles this, expect the market pain to continue.

We believe the recent plunge across markets is more attributable to fear than actual weak data.  If that holds true, there is a chance that the current dip in rates represents a bottom.  Buying a cap or locking in a swap may look pretty attractive in a few months if fears of bad news dissipate and market expectations move back up in line with FOMC projections.