This post is more a case of ‘food for thought’ than an outright prediction.
What if Yellen broke with convention and decided a hike of less than 25bps was the most appropriate measure to begin a new tightening cycle?
Less than 24 hours from now, US Federal Reserve Chair Janet Yellen will front the world’s media and potentially deliver the first US rate rise in over nine years. To say that a lot hinges on the announcement and the accompanying statement is underplaying the significance of the event. The Fed has arguably backed itself into an unenviable position by delaying the first move in the tightening cycle for so long and has, on more than one occasion, left markets wrong-footed by providing somewhat equivocal ‘forward guidance’ (not something market participants are fond of last time I checked!).
Since this ‘will they/won’t they?’ saga started, we’ve witnessed the dollar index stage a circa 25% rally, both debt and equity in certain emerging markets have been pushed to the edge of failure and US equity markets have effectively gone nowhere in over a year, notwithstanding some hugely volatile (read: nerve racking) moves. To add to the drama, the energy industry has had to face the economic realities of an unconventional oil & gas evolution, which has in turn left US high yield bond index investors nursing painful losses –once again something those market participants are neither fond of, nor accustomed to.
As we lead into Thursday’s announcement, equities globally are looking like chickens in a barnyard – lots of dust and noise, but completely unsure of themselves and ultimately going nowhere. Bond and currency market players have seemingly all taken a risk-off, follow the consensus approach (a great risk-on setup for astute punters?) and have implemented positions heavily weighted towards the Fed delivering a garden variety 25bps hike. Economists are similarly all on one side of the boat (once again signalling great risk/reward to run against the herd).
So we have an out-of-consensus view for you: A ‘goldilocks’ 10-15bps rise that simultaneously silences the critics suggesting that the Fed measures its success by where the S&P is trading and also stops a full blown panic developing after five-plus years of experimental – errrm, sorry, ‘unconventional’ monetary policy.
It would be a bold, but arguably sensible step for the Fed to avoid the obvious granularity of moving interest rates in 25bps increments off what has been a zero base over the last six years. And in the Fed’s favour it might just cause US equities to rally as a signal the US economy is strong enough to deal with a rate rise, whilst at the same time not causing bond investors to start manning the life boats. Not too hot, not too cold.
Given that we know market positioning, and the usual suspects continue to imply that only a single outcome is inevitable this week, we are happy to suggest that there is possibly just enough doubt in Janet Yellen’s mind that ‘unconventional’ doesn’t just mean changing people’s understanding of the limits of monetary policy……it also means changing the fundamental building blocks of what market participants previously took to be a given.
This article was submitted by Nick Briscoe, Head of Macro Research, Invast Investment Committee.