In his preview of today’s release of the January FOMC Minutes, which as a reminder were Janet Yellen’s last and took place just before the February market correction, Rafiki Capital’s Steven Englander wrote that “the most likely surprise in the Fed Minutes tomorrow is that they may be leaning to four hikes in 2018, but the biggest surprise would be growing support to aim for above two percent inflation temporarily to make up for previous misses to the downside.”
As a reminder, after tumbling to 4 year lows, the Dollar has been on a steady uptrend in recent days, while rate hike expectations are now at their highest of the cycle – 2.76 hikes in 2018 are priced in (despite stocks still not being anywhere near back to pre-Powell-put-implied levels).
Commenting further on the “most likely surprise”, Englander – the former head of FX at Citi – added the following:
The three versus four hike debate is already in the open with several FOMC participants referring to the possibility of four hikes. About 70bps are now priced in, versus around 65bps just before the meeting. The FOMC meeting occurred before high AHE and inflation prints, but in recent meetings the MInutes’ discussion has become more confident that inflation is picking up. I think the risk is much greater that they signal growing confidence on inflation moving towards target more quickly than any indication that two hikes might be more appropriate than three. This would not mean a strong, overt signal of four hikes but it is likely they could convey ‘three, maybe four’ as their stance. They are unlikely to go full hawkish in the Minutes as there have been only moderate hawkish signals since, and monetary policy was probably discussed in between tinkling champagne glasses at Fed Chair Yellen’s last meeting.
Throwing his 2 cents into the hat, in his latest letter Dennis Gartman also lays out what he will be watching:
there are two words in them that we shall need to pay heed to: “Few” or “several.” That is, will the minutes suggest that there will be “few”… meaning three… rate increases through the remainder of this year or will there be “several” … meaning four. We hold with the latter.
While hardly as simple as that, these two excerpts effectively frame the big unknown behind today’s FOMC minutes, and the linguistic nuances that analysts will look for in the text: 3 or 4 rate hikes.
* * *
Number of rate hike aside, here’s what else to look forward to in today’s minutes, courtesy of RanSquawk.
The last FOMC meeting under Yellen’s tutelage saw the FOMC keep interest rates unchanged at 1.25%-1.50% and pave the way for further gradual rate hikes going forward. The statement was more hawkish than some had anticipated as the Fed altered their language around inflation, removing the phrase that inflation was “to remain somewhat below 2% in the near term.” The other important change was the addition of the word “further”, as in “further gradual increases” will be necessary.
“Given that the January FOMC statement upgraded the inflation language and the characterisation of economic activity, we would not be surprised to see the January Minutes also having a hawkish tone,” writes Société Générale. “Given that market participants are worried about the fact that the Fed may end up hiking four times in 2018 versus the median projection of three hikes, a hawkish tone in the January Minutes would be unsettling.”
The comments on inflation will likely take much of the focus given the language change in the statement as market watchers try to gauge how the much confidence they have in the inflation outlook. The January meeting pre-dates the latest CPI data from the US which saw the Y/Y rate hold at 2.1% despite expectations of a dip to 1.9%.
“It is clear that underlying inflation is accelerating,” said Capital Economics. “There are good reasons to expect this pick up in core inflation to run further in 2018.”
Markets are currently pricing in a near 100% chance of a rate hike at the March meeting and the Minutes will likely reinforce expectations of a 25bps hike if they appear positive on the inflation outlook
Capital Economics question whether there will be any discussion by the Committee on potentially reconsidering the Fed’s policy framework. Currently the Fed’s mandate is achieve 2% inflation and full employment in a balanced manner but recently some Committee members have voiced concern over that approach. Boston Fed’s Rosengren has suggested replacing the 2% target with a target range of between 1.5% and 3.0% while others have suggested targeting an average of 2% or even raising the target to 4%.
Another point to be aware of is the publication of new Fed Chair Powell’s first monetary policy report on Friday (Powell does not testify to Congress until 28th February). Powell’s Fed is widely expected to follow the same path that Yellen’s Fed had undertaken – gradually normalising rates – but this will be one of the first opportunities for Powell to stamp his mark on the Committee. Since the last meeting, US wage and inflation data has been stronger than expected, prompting some volatility in markets but it’s worth noting that the Fed will have another set of labour market data before the next meeting in March, which should show whether the higher than expected earnings in January were an anomaly or the beginning of an upward trend.
The recent market “turmoil” came after the Fed’s January meeting and so there should be no comments on the volatility that was seen in the first weeks of February.
Markets are currently pricing in approximately 65% chance of three hikes in 2018 and 22% chance of four hikes this year. If the FOMC Minutes reaffirm the latest statement and show they are confident in the inflation outlook, markets may begin to fully price in four hikes in 2018 and US yields could continue the meteoric rise seen recently. However, the correlation between rates and the USD has broken recently and higher yields may not necessarily translate into a stronger USD. ING note that as long as the rise in yields is orderly, this is likely to translate into ongoing broad-based USD weakness, while EM FX should retain support.
* * *
We close with an anecdote from Dennis Gartman, highlighting that if the Fed really wants to shock inflation into submission, it will certainly try:
… we’ve all grown far too accustomed of late with rates moving 25 bps when in the past rate changes were many times 50 and 100 bps… or more! Indeed, there were times when the o/n fed funds rate moved 200 bps as happened at the July meeting in ’71 when the funds rate rose from 3.5% to 5.5% and in August of ’73, moving several times from the level prevailing at the April meeting of 7.25% to 11.0%! In ’74, between the February meeting when the funds rate was 9% it rose to 13%, and it fell to 8% by the December meeting.
Further still, there are other examples of such now seemingly “impossible,” material changes in the funds rate. Thus, it is worth remembering that from the April meeting in ’79 when the funds rate was 10.25% it rose in large increments to 15.5% by the October meeting. Finally and most impressively from the January meeting in ’80 through the March meeting… a scan six weeks… the Fed funds rate soared from 14.0% to 20.0%. We remember it well for it set the stage for an even larger rise between the June meeting when the funds rate had fallen to 8.5% to 20% again at the December meeting.
We bring these “tales” of volatility to the fore this morning for the simple reason that we have all become too complacent when it comes to the Fed’s history. The past decade’s non-volatility is an anomaly… a long one to be certain, but an anomaly nonetheless. When we said several weeks ago for the first time that we thought the o/n fed funds rate would be taken higher four times this year and that it would move in the aggregate by more than 100 bps we were laughed at. We stand by our forecast, laughter be damned.
And with that in mind, it is perhaps time to start worrying about the Fed cutting rates in the not too distant future…