The Fed's gambit

Raise your hand if you saw that one coming.  After five months of prevarication, the Fed was as clear as it's been in a long time that not only is June still on the table, if things go as planned it's more likely than not.

Most participants judged that if incoming data were consistent with economic growth picking up in the second quarter, labor market conditions continuing to strengthen, and inflation making progress toward the Committee’s 2 percent objective, then it likely would be appropriate for the Committee to increase the target range for the federal funds rate in June.

Retail sales and IP are both consistent with growth picking up, and the CPI with continued progress on inflation.    That oil remains near six month highs does little to steer the message away from conditions evolving in a way consistent with a rate hike next month.  Even the Brexit polls are playing ball, as long as you're not long 2 month cable vol.

Of course, it wouldn't be the Fed if they didn't leave themselves an out.  The minutes specifically cited the Brexit vote and Chinese currency policy as potential threats to market stability.  One need only be slightly cynical to view the latter qualifier as virtually rolling out the red carpet for China to engineer another RMB wobble against the dollar (that it weakens against the basket apparently goes without saying these days).   Stay tuned.  The DXY is already looking perky- USD/JPY above 110, USD/CAD north of 1.30, and the dollar index threatening to break the levels that have constrained it for the last couple of months.
Nevertheless, they evidently put a plan in place to start banging the drum:

Some participants were concerned that market participants may not have properly assessed the likelihood of an increase in the target range at the June meeting, and they emphasized the importance of communicating clearly over the intermeeting period how the Committee intends to respond to economic and financial developments. 

Who knew that Eric Rosengren is in fact the man behind the curtain?  In fairness to the Fed, this looks exactly like them doing what Macro Man has thought they should have been doing all along: telling the market what it wants, rather than vice versa.  In a parallel universe where ZIRP-world is only a fantasy bed-time story meant to scare young central bankers-to-be, pricing a hike for June would be a chip shot given this language.

Unfortunately, that's not the world we live in, and the prospects probably remain more tenuous than that language would suggest.   It will be very interesting, for example, to see how the Fed would react if markets were only 40% priced for a June tightening on the day of the announcement, given their historic predilection for only hiking when it's not a surprise.  If they don't want to face the challenge, then their task will be to guide markets as forcefully as they did today.   A bang-up payroll figure next month would obviously help do the job for them.  

As you can see, yesterday's minutes took the chance of  Jun tightening from virtually nil to a 1/3 chance in one shot.  Further upside should be easier to come by from here, particularly if the data is strong and/or any of the Board of Governors big shots echoes that June is looking odds-on.

What will it mean for markets?  On the face of it, it looks quite clear.   5 year yields registered a very clean break of the downtrend that has defined yields this year, putting in a higher high (to go with a prior higher low) in the process.  On a host of measures, further upside beckons for yields. 

For equities, meanwhile, the outlook is less sanguine.  Macro Man ran a little study using the third Fed funds futures contract as a proxy for imminent policy expectations.   He compared the trailing 4 week move in Fed pricing with the subsequent 4 week price change in the SPX.  As you can see, the relationship is generally quite negative (correlation of -0.62 over the last year or so) and would appear to argue for more weakness from here, yesterday's flat result notwithstanding.


Where it gets tricky, of course, is if financial conditions tighten too much (higher yields, higher dollar, weaker stocks) before the meeting.   Given that these are all a natural response from ratcheting up expectations of the policy trajectory, the next four weeks may well off punters both the thrill of victory and the agony of defeat.   What seems clear, however, is that while the Fed may have made an opening gambit, it's unlikely to proceed directly to the endgame.  For choice, though, Macro Man would expect recent moves (higher dollar, higher yields, weaker GDX and stocks) to continue a while longer before policymakers are prepared to react to the market's "counterattack."
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Anonymous
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May 19, 2016 at 8:51 AM ×

lovely post as always..far better commentary and analysis than anything an interbank sales could have copy-pasted.

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Skr
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May 19, 2016 at 9:29 AM ×

MM- there will probably be position adjustments by any caught off-guard, in the next week or so. After that I doubt it will be a black Swan event, that will trigger the next big move, more likely a Mickley Mouse excuse once positioning is onside (whichever way that is?).
I have the score at 1-1 (JBTFD'ERS/ H&S) after extra-time, penalty shootout to begin.

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Anonymous
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May 19, 2016 at 9:42 AM ×

This looks like a rise where multiple groups are going to be offside , guvvies;commodities and Equities. Given where margin debt is that makes a sort of sense in encouraging the market to carry on deleveraging.

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Error404
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May 19, 2016 at 11:53 AM ×

"What seems clear, however, is that while the Fed may have made an opening gambit, it's unlikely to proceed directly to the endgame."

Dead right. Until proven otherwise, the 'Great Central Bank Dissonance Engine' must be assumed to be still grinding away in the background. Whereas the minutes reflect all colours in the FOMC spectrum, it's really only light being emitted from the Gang of Three which is capable of generating policy heat. With two of this mini-Politburo scheduled to speak today, it'll be interesting to revisit the discussion in 24 hours.

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washedup
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May 19, 2016 at 12:25 PM ×

The problem with the 'most participants' language is that they most likely don't include market whores-in-chiefs yellen and dudley, and clearly they are the ones ultimately driving the show.
What the fed really must be working on behind the scenes is to tinker with the excuse machine so it can come up with a new reason to not raise rates even if inflation goes to 3%, there is no brexit, spoos head to 2200, dollar index to 85, and crude to 60, for the simple reason that they do not want to deal with what happens if things go pear shaped.
These guys have zero credibility already - that tells me what everyone should be most nervous about from a material risk on/risk off perspective is either an unexpected rise in inflation or a messy selloff in the long bond, regardless of what the dollar is doing - everything else is chop.

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Polemic
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May 19, 2016 at 1:18 PM ×

mopre dovish , more hawkish, more dovish, more hawkish. Every time it surprises the market one way or another so is it worth all the ball ache in-between? Now that everyone is stunned into the 'more hawkish' mode we can prep for a more dovish next event .. yaaaawn

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Anonymous
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May 19, 2016 at 1:27 PM ×

"if incoming data were consistent with economic growth picking up" -

I chuckle when I see anyone discussing "growth" anywhere in the major economies (Euro, Japan, China, U.S.). While many visiting here appear to trade on whatever their analysis is, I'd be interested in thoughts on a "Macro" level as this so-called growth is DEBT fueled imo. These debts are in no way, shape, or form, ever going to be paid off. Central Banks are simply adding to their own balance sheets in one form or another, while governments, coporate, and households go "full retard" on debt. In the U.S. alone, take away the deficit spending punch bowl and we have insta-negative GDP.

Like beauty, I guess "growth" is in fact in the eye of the beholder.

https://research.stlouisfed.org/fred2/graph/?g=3Y7i

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Booger
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May 19, 2016 at 1:27 PM ×

I am amazed that the market can still get excited about fedspeak at this point. I mean 1 interest rate hike in 9 years and an endless cycle of tough talk and no action. It is hard not to surmise that they do actually think that they need to talk hawkish periodically to maintain their credibility.

By it's actions, this must be the most dovish fed ever. So it will be interesting to see whether the market will fall for the bait again about tightening talk. I tend to think it is likely that has lost most of it's traction. I don't trust the current strengthening in the dollar. There is no risk aversion to back it up and FOMC minutes will have a short half life. Data and fed forecasts are no better than in April so there is buckley's chance of them actually hiking in June and that will start to get priced out again between now and June. Not that dollar weakness is worth punting on either. I am just going to keep my powder dry and wait for a further bounce in equities to add to short position and a final correction in the dollar for a more likely bottom to go long from. Oil is getting close and at $50 would be in a good zone to short, but the dollar doesn't look like it has bottomed.

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abee crombie
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May 19, 2016 at 1:50 PM ×

from you know who

"So, as we have argued since February, there exists a catch 22 for the FOMC. Their policies are basically boxed by the PBOC - and that concept has been the centerpiece of our currency war detente theory. But as the data become more and more robust - for example the recent retail sales and CPI reports - the FOMC look more and more foolish. They have to appear to be somewhat responsible and reactive to the data. Their stories of excess labor market slack, slow wage growth, weak investment and global headwinds can only go so far.

So what's the optimal strategy for the FOMC? Well, I would argue that as long as the financial markets look stable, they have an incentive to keep testing the waters for rate hikes. Thus the recent hawkish messages from Dennis and John make perfect sense, as do the hawkish minutes. They send out a large bark, see how the Chinese and spoos react, and then adjust the bite. If they can get away with a hike which doesn't agitate the Chinese (and keeps spoos on solid footing) then its mission accomplished. But if the Chinese start pushing the USDCNY fix up, as they did last night, and spoos start to shake, the bark turns back into a whimper.

In essence, the storyline has not changed since last August. The PBOC are more or less in control of FOMC policy. And the Fed folks are just poking around to access the state of their policy freedom. I still don't believe the dovish members of the Committee want to meaningfully tighten. But I think all Committee members recoginize the optics of 5% unemployment, 2% core inflation and a 50bps fund rate look suspect. Janet would love to have slightly more normal policy conditions, if only Zhou Xiaochuan would let her. Good luck trading. "

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abee crombie
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May 19, 2016 at 1:52 PM ×

yay, everyone lets day trade the S&P, because surely there is informational value in every move.. So sad what economists, politicians and CB's have become

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Anonymous
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May 19, 2016 at 2:07 PM ×

@Nico - Looks like that Swan was for a plane. Man, am I getting the shivers about flying any time soon. Two Egyptian, MH307, Ukraine, the suicide pilot, Brussels airport etc.

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Anonymous
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May 19, 2016 at 4:01 PM ×

At current daily average, May's corporate bond issuance will be almost $260B. Largest since May '13, if not ever

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washedup
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May 19, 2016 at 4:06 PM ×

@anon 4:01 when I saw that note from Goldman urging their clients to shun equities and buy corporate bonds I was wondering when I'd see that headline - didn't realize it would be within a week!

Quick, kids, run to the candy store before it closes - don't worry about that pied piper looking guy behind the counter either, he is just there to entertain you kids with his music…..

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Anonymous
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May 19, 2016 at 4:20 PM ×

China Inc.'s grim balance sheet - in this week's Nikkei Asian Review.

http://asia.nikkei.com/magazine/20160519-China-Inc.-uncovered

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johno
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May 19, 2016 at 6:35 PM ×

Agree that USDCNY has to be watched, but last night's fix was actually less than predicted by models and USDCNH actually fell. So, though last night's fix was up, I don't think we should take it as China signaling displeasure with the prospect of the Fed hiking rates once. Not yet, at least.

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washedup
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May 19, 2016 at 9:10 PM ×

2040.04 - the bull market is A-OK by a smidgen!

Interesting stick save on crude in the face of dollar strength - I guess commodity traders are smarter than currency traders when it comes to, um, forecasting currencies - with the notable exception of booger.

Not saying tomorrow won't be a 30 point up day,but this may be the weakest option expiration price action I've seen in a while. A few quarters ago the fed could've said rates will be going up everyday in 100 bps clips and spoos would have laughed on their way to 2100.

Interesting times.

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Anonymous
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May 19, 2016 at 9:17 PM ×

Looking at the f*ckery in SPX and with the Fed, makes me hope Trump gets voted President.

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Anonymous
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May 19, 2016 at 10:45 PM ×

40 years ago...
$SPX was at 99.57, the Dow was at 932.50 & $BRK.A ($211,180) was at $100 (21.7% ann comp)

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Leftback
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May 19, 2016 at 11:39 PM ×

Nice summary, MM.

A day of completely pointless d*cking around tomorrow into expiration while they play pin the tail on the donkey on low volume? Yeah, I expect so, but then it might get a bit tasty next week. Please don't be surprised to see Bucky surge overnight Sunday into Monday and then a nice commodity and equity slaughter Monday morning.

The 5y turned out to be the place not to be.... the belly of the beast. Our short CADUSD is working nicely now. A bit of price discovery in the oil market might be next and then we'll see another leg down in the Caddy.

This week the best trade was long June and July dollars. There will be more weeks like this... Granny isn't coming to save the Tiny Punters this time. La Paloma Blanca is caged, the hawks are in flight for the time being.

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Cityhunter
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May 20, 2016 at 11:50 AM ×

@LB, Nice on CAD

Fed risk coming quicker than China risk.

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