Today's Federal Reserve meeting is overshadowed by two looming events. First is the December meeting, which is likely the next time the Fed will consider actually moving interest rates. Second is the announcement of President Trump's nominee for the chair. That should be made official tomorrow, but it has been widely reported that Jerome Powell will get the nod. I've written extensively about how this next chair will shape Fed policy (most recently here, here and here) so I won't rehash any of that now. Instead, today we'll break down the Fed's release, what it tells us about December, and how this influences some of the trades I currently like.
What Did the Fed Actually Say?
Not much that we haven't already heard. It had to mention the fact that employment dropped in September, but we all know that was hurricane-related, so no harm no foul. Similarly, the Fed mentioned that headline inflation has been influenced by gasoline prices post-storms, but underlying inflation remains soft. When it came to describing the broad plans for interest rate policy, there was no change.
So We Learned Nothing From This Press Release?
Maybe not on its own, but taken in conjunction with other Fed sources, including speeches, the Beige Book, etc., I think it is safe to draw some firm conclusions. The majority of FOMC members are unsure of why inflation has recently slowed a bit, but believe it will be temporary. They are seeing enough anecdotal evidence that wage pressure is building and/or they are worried about financial market excesses, and thus want to keep slowly tightening policy. The general thrust of the economy seems to be accelerating a bit, which gives them room.
Seen through that lens, it should be obvious that a December hike is coming. If inflation prints are slightly lower in November, the FOMC will still see the slowdown as transitory. The labor market will still seem very tight. There is no reasonable data that can come that would reverse that view.
So Is a December Hike a Done Deal?
The market still doesn't quite think so. Just prior to the Fed's announcement, fed funds futures showed about 83% odds of a rate hike in December, without much movement after. I'm not sure what the holdouts are thinking, but it won't matter much. Pricing in that last 17% won't move the market meaningfully.
More interesting are the odds for two hikes by June 2018. I think two are very likely and three are a distinct possibility. Instead, the market has about 44% odds of two hikes and 16% odds of three. I think those odds are more like 75% and 50%, respectively. That is really what we should be tracking between now and then.
One Last Word on the New Fed Chair
If the rumors are correct, and Powell is about to become Fed chair, the general consensus will be that he's a continuity candidate. I suppose I agree with this for the next few months, but beyond that we just don't know. Ultimately how the next chair conducts policy will have everything to do with how they react to slightly lower or slightly higher inflation. All we really know about Powell is that he publicly supported current Chair Janet Yellen's strategy to date. We have no idea how he might have reacted differently had circumstances been different.
I think we can expect Powell to run the Fed like a CEO, where he listens to his lieutenants and then draws a conclusion. Since he isn't a macroeconomist, he is less likely than Yellen or Ben Bernanke to bring his own theories to the table. Again, we can't know this for sure now, but it strikes me that the people surrounding Powell will be a bit more important than was the case for Yellen or Bernanke. If that's true, who Trump picks for vice chair and the other board seats may matter more than the market is assuming.
I still like being long the dollar. We are mildly off the highs since Powell seems to have emerged as the most likely chair, but I'm still up 4% since making the recommendation. I think there are a couple of percentage points left as we price in the December hike. I'll reconsider then.
I also still like shorting three- to seven-year Treasuries against a long of the 20- to 30-year Treasuries. I've mostly closed my outright short of the five-year, which doesn't seem to have as much immediate upside given a Powell-led Fed.