But the crucial takeaway is that Yellen left a rate hike as early as September on the table, with November and December also in the picture. Basically, the fed is leaving the door open for a hike this year, but they are uncertain exactly when at this point in time.
Currently, the probability of a hike in the Fed funds target rate in September stands at 33%, up from 21% the day before Jackson Hole. The figures for a rate hike in November and December are 38.5% and 59.1%, up from 27.5% and 51.8% previously. [Note: These are the probabilities of the fed funds rate not being between 25-50 bp, the current rate. The latest figures can be found on the CME Group FedWatch Tool]
 |
| More than a coin toss chance! |
Simply put, the market expects more than a coin-toss chance of a hike in December, for good reason too. While I am in favour of the fed raising rates and normalising monetary policy, I don't see that happening in the coming months until December, lacking any catalysts or unexpected turn of events. I have a few reasons in mind for a December hike:
1. September is too close - Honestly, I don't think Yellen will risk hiking so soon after Jackson Hole. Even if economic conditions/economic data justify the hike right away, the market has not fully come to terms with the possibility of a rate hike coming so soon. This will spark a selloff like we witnessed last July, and investors will pay dearly for it. Yellen probably wouldn't risk such a thing happening.
2. November seems plausible, but there's a presidential election coming up - The markets hate uncertainty and unexpected outcomes. Remember June's British Referendum? The Fed wouldn't have hiked under the uncertain circumstances then even if data permitted anyway. Same reason applies to November.
3. Credibility - The Fed was expecting up to 4 rate hikes this year but so far none have materialised. The market is getting impatient trying to guess the timing of the next hike as the fed keeps on dragging their feet. After waves of quantitative easing and unconventional negative interest rate policies around the world failed to kick start any steady growth, central banks around the world have taken a hit to their credibility.
The Fed risks losing its credibility if it does not even make a move this year, as projected. In line with their "wait-and-see" approach to rates, a hike in December makes sense given that they've waited and observed one year worth of data (more than sufficient make a decision?) since the last rate hike in December last year.
4. Timing - December is typically when markets quieten down and trading volumes decline toward Christmas and New Year. With seemingly fewer players in the market, any potential market reaction to the hike would hopefully be less pronounced. (However, thinner liquidity may exacerbate the extend of market movements) Also, with a year since the last rate hike, and sufficient time to talk up and prepare the market for a hike, the financial markets would hopefully have already priced it in and therefore have a more subdued reaction.
Barring any unforeseen circumstances or catalysts, I believe the fed will only hike once this year, very likely in December. Between now and then we could expect Fed officials to begin talking up the prospects for a rate hike (hawkishness) to prepare the market before it comes.
Mr Market has been enjoying low rates for very long and is now hooked on it. He's bound to throw a tantrum should there be a sudden hike. The Fed will need time to cajole him and prepare him for higher rates to come in due time.
Just my two cents,
Market Oculus
