Originally published by AxiTrader
As a behavioural economics and finance guy I'm interested in how prices move, how positioning changes, how data prints relative to expectations, and how rhetoric changes - all of these through time.
The reason I watch these aspects rather than just the "economic fundamentals" is that this allows me to get a sense of the markets psychology at any given time.
One of the other things I like to do when it comes to my world of behavioural trading is work out where the markets are anchored. That is, where the primary reference point is for the beliefs traders hold and how that impacts the decisions that they make when they place their investments or trades.
It is with this framework that I turn my attention to the next FOMC meeting and the real chance of a rate hike in March.
While last night the CME's FedWatch tool saw an increase of 9% to 35% in the implied odds of a Fed tightening in March I think the market is still underpricing the chances of a Fed rate hike. I say that because many investors and traders are still anchored in crisis thinking and where we’ve come from rather than we are and where we should be heading. Take for example the Atlanta Fed’s Taylor Rule estimator – It says rates should be around 3%.
Take for example the Atlanta Fed’s Taylor Rule estimator – it says rates should be around 3%.Yet we constantly hear that rates need to stay low in the US.
This Taylor rule is of particular import because of the discussion in some circles of US academic thought and monetary policy that the Fed should be running a kind of systematic Taylor rule style regime under which its discretion is limited as it follows this type of model.
But as highlighted above current CME pricing suggests 65% against and 35% for a tightening. Odds that low would normally preclude the Fed from raising rates because of the surprise factor and the potential to cause market ructions.
That makes Friday a huge day for US and global markets. That's because we have Fed chair and vice-chair Yellen and Fischer speaking along with Evans, Powell, and Lacker all of who also speak.
Already last night Dallas Fed president Robert Kaplan laid down the gauntlet saying that the time is nigh to raise rates. He told a gathering of university students that even if the Fed raises rates “a few times” in 2017 monetary policy will still be in stimulatory territory.
That for me is the key. If we are still thinking and acting like the US is in a crisis then rate rise could threaten the recovery. But the US economy has turned, data has been consistently beating expectations for months - predating the election of president Trump. And long term indicators like jobless claims show the 4-week moving average hasn't been this low since the early 1970's.
Likewise, the Atlanta Fed GDPNow tracker has Q1 2017 growth running at 2.5% as at last night.
That's not super strong. But neither is it consistent with rates of just around half a per cent at the front end of the US interest rate curve. Something the Taylor Rule framework explicitly suggests.
Besides Minneapolis president Neel Kashkari and maybe St Louis Fed’s Bullard, the Fed has pretty much been singing from the same hymn book recently. So while we won’t get non-farm payrolls till the 10th this month – right before the Fed meeting – this first Friday of the month is just as important with all these Fed speakers.
I’m in agreement with Allianz (DE:ALVG)'s storied adviser Mohamed El-Erian who tweeted last week that a 50-60% probability is probably more likely the true chance of a Fed rate hike in March.
My sense if the Fed is going to try to move the market into the upper end of this range before the blackout period begins.
If they can't move the needle on market expectations then I would expect March to be a firm signalling meeting. That is they can almost generate the same impact on market pricing by signalling their intention to hike in May.
Naturally the impact of this could be a stronger US dollar, some headwinds for the gold and equity rally, and perhaps take a little wind from the commodity rally's sails.
But the Fed is tightening because the economy is strengthening and at the end of the day after any initial hicups traders and investors are likely to refocus on that.
Have a great day's trading.