The release of the meeting minutes from the Federal Reserves October meeting confirmed the hawkish market expectations, moving the needle on the implied probability pricing of a move to around the 77% level. While the meeting minutes firmly alluded to the probability of a December move data dependent naturally, the more meaningful takeaways have been from recent FED speakers, who continue to coalesce around the increasing probability of a December lift off.
Fundamental Flows
The minutes reinforced the comments from FED speakers, as they indicated that most participants thought that if economic conditions evolved in line with their outlook (which they mostly have), liftoff would be warranted by the December meeting. Also, the minutes explained why the Committee decided to change its forward guidance (i.e., the conditions necessary to raise rates “at its next meeting”). The minutes suggested that this change was made to convey the view that if economic conditions evolved in line with its expectations, a December liftoff would probably be appropriate. These discussions coupled with recent rhetoric from FED speakers, reaffirmed the market’s expectation for a December liftoff. With the timing of liftoff all but set, the discussion appears to have moved to the pace of adjustment. The minutes provided only qualitative guidance on the expected pace of rate adjustments as it stated that FOMC participants “generally agreed” that it would probably be appropriate to remove policy accommodation “gradually.” One theme that emerged from the minutes that is noteworthy was the discussion of ‘equilibrium real interest rate’ this is essentially a technical term used by the committee in reference the the glide path and pace of monetary normalization. Both the board members and staff seem unified around a sense of reluctance to commit to any dramatic moves in the headline rate, whilst they agree a rise is most likely in the cards they are significantly less committal to the pace or duration of policy adjustment. The board broadly accept it highly unlikely that the rate glide path is likely to return to levels witnessed before the great recession of 2009, where the equilibrium rate was circa two-three percent, which implied a headline rate of four to five percent as being neutral. The FOMC expressed doubts about how quickly the equilibrium rate would return to levels that were common before 2009. A key question then is whether the FOMC will revise its short-term rates forecast (the “dots”) at the upcoming FOMC meeting. The bottom line is that the FOMC seems to be signaling that it is unsure about how far, and how quickly, it will raise rates after liftoff. The current FOMC forecast implies that it expects to close the gap with current estimates of the equ by early 2017. But these forecasts may come down at the December meeting. The minutes also stressed the uncertainty around estimates of the equilibrium rate. None of the empirical models suggest that we can estimate the equilibrium rate with precision. Ultimately, the FOMC will be constrained by what the economy can handle.
With the Thanksgiving holiday today, this week’s data was front loaded. The data this week was broadly in line to slightly better than expectations and continues to reflect an economy that is growing at a steady pace. This ‘chugging along’ nature of US economic development has the door firmly open to confirming policy normalization at the December 16th meeting.
Trading Take Away
From a trading perspective, the strategy remains the same: I am looking for a double top to develop which I will look to play from the short side, we came close to testing highs this week but have yet to see a full retest of the March peak, I will be monitoring a move to this level or a test of the stops above for an intraday reversal pattern where I will venture short, targeting a retest of the breakout level where I will reassess the price patterns looking to reverse long for a retest and break of highs.