By Michael Connor
NEW YORK (Reuters) - Dovish investors are going to be disappointed by the Federal Reserve's policy-setting open market committee who are meeting now and should hedge against policy outcomes likely to rattle global markets, Weeden & Co. derivatives strategist Michael Purves said on Tuesday.
Purves told the Reuters Global Markets Forum chatroom that expectations for interest-rate levels between policymakers and markets were extraordinarily wide.
That gap carried the biggest risks of losses for investors betting the Fed will soon resume rate cuts and balance-sheet policies in place since 2008's financial crisis, Purves said. The Fed will issue its decision and an accompanying statement on Wednesday.
Here are excerpts:
Question: What do you expect to hear from the Federal Reserve on Wednesday?
Answer: Most agree that we will see the Fed lower its rate-hike expectations and give some comforting language on the balance sheet. But my question is whether the (messages) will be skewed for the hawks or the doves? (Even) if the Fed lowered by two hikes from December, that would still be north of where the market is. So, to deliver a net dovish message, the Fed must really deliver two hikes lower than December, (and) a strong message on the balance sheet. ...It seems a big ask.
Q: Why do you think the Fed may surprise on the hawkish side?
A: One key factor is the Fed pivot – the heightened market stress shown through VIX and higher credit spreads in Q4 – has largely reversed. Further, breakeven inflation rates and commodities have rallied substantially since the dark days of December. So, if you look at the 10-year yield, you can see its trajectory lower over the past several months has been solely defined by rates-hike expectations, while ignoring other factors such as inflation. Another factor is lower foreign sovereign yields.
Q: Where would the current 10-year yield of 2.60 percent be ordinarily?
A: We could easily be above 2.80 percent and perhaps trending towards 3.0 percent.
Q: What should investors do?
A: Buy some hedges for asset classes sensitive to a net hawkish message tomorrow. For example, EM (emerging markets), commodities, and even the overall market.
Q: Which things should investors watch Wednesday?
A: Fed funds and Eurodollars (money markets) are very volatile and kind of manic depressive. They can swing. Keep an eye on the 10-year Bund. It is extremely low. Be mindful of how EM assets trade; they may in fact fight through a net hawkish FOMC tomorrow.
((This interview was conducted in the Reuters Global Markets Forum, a chat room based on the Eikon platform.))