Not what, but how

The key for the Fed today is not what they do, but how they do it.   The expectation for a 0.25% hike today is universal, and there seems virtually no scope for any sort of surprise on that front.  Where the uncertainty lies is on how the committee chooses to frame its decision, most importantly with regards to expectations for the future.

Readers may recall that at the time of the last (err....only) rate hike, the median FOMC dot plot forecast projected a further 4 hikes this year.  That clearly hasn't happened.   Ever since global markets took a stumble in the first couple months of the year, the Fed has taken a softly, softly approach to both its reaction to economic developments and its assessment of optimal policy settings moving forwards.

While the Fed is of course (cough, cough) apolitical, the surge in consumer and business confidence since the election, alongside a significant run up in risky asset prices, might ordinarily warrant an upgrade to the ho-hum forecast of 2% growth and inflation around target.  Then again, despite the apparent ecstasy in some corners of the business and economic universe, Trump hasn't actually assumed office yet, let alone delivered on his cornucopia of promised goodies.  Senate support for the infrastructure bill, for example, appears lukewarm at best.

It's therefore pretty easy to see the Fed standing pat on its growth forecasts.  Might there be some slight upward shift to the inflation forecasts?  Perhaps, though again any meaningful change will require an uptick in spot inflation (which may indeed be coming) or an actual change in delivered fiscal policy, not promised.

We're so used to the Fed delivering dovish surprises....is there another in the pipeline for today?  Well, the current one year forward median projection for the Fed funds is 1.125%...two hikes for next year.   There's not much room to ratchet that lower without a shock of bad news.

The two year forward projection is 1.875%, representing an aggregate of 5 hikes over the next two years (the second of which will not involve the current leadership.)  Is it possible to knock that lower?   Sure, though not by a whole lot.   In any case, it's also not clear that the market will listen in
its current ebullient mood.

What is interesting, however, is that for the first time since the end of the taper, market pricing has exceeded the median dot projection looking out two years.   While this is interesting in and of itself, term structure based policy models would view this as providing more leeway to tighten policy in the future.  While it also suggests that the market is ripe for disappointment, it's been pretty clear that developments in fixed income markets have been predicated on expectations for fiscal policy and the real economy, not monetary policy.   As such, markets may be willing to look through the "same old, same old" from Yellen and co.  After all, on short to medium term horizons the market has tended to trade on a momentum basis relative to Fed projections- taking developments bullishly when less than the dot plot is priced, and bearishly when more is priced.

One thing that does give Macro Man pause, however, is the technical picture in bonds.  US 10 year notes are exhibiting the sweetest example of divergence that you'll ever see, with yields making higher highs ever as momentum makes lower highs.  That's a classic example of a trend in exhaustion mode and ripe for a pullback.   Add in the looming prospect of pension rebalancing (quarterly and annual) and you could see a decent bid emerge for bonds in the coming weeks.

Macro Man has therefore dipped his toe this week and bought some Treasury duration.   While the Fed may seem unlikely to provide a catalyst, they may not actually need to for the trade to work.   With positioning extended and momentum waning, it's a classic set up for a bit of mean reversion.  There's never a guarantee, of course, but given that yields have held in there this week even as equities soar, just imagine what they might do if stocks ever have the temerity to tumble!