Behind the Curve? Pussycat Yellen Confronts “Largest Dovish Policy Deviation Since the 70s”

By Heisenberg

Some folks will be talking about the Fed today.

In just a few hours we’ll get a hike, but once again, it’s all about the messaging. Any kind of dovish lean would be a (bigly) surprise. What’s got some people spooked is the possibility that, in their rush to prove they aren’t behind the proverbial curve, they get too aggressive with the messaging. Here’s what SocGen said overnight (and please, just forget that you ever heard the term “pussy-cat” in a sentence that refers to Janet Yellen):

The Fed is a pussy-cat that would like to change its spots into something more like a leopard’s. In practical terms, that means that this evening’s FOMC announcement (6pm GMT, with a press conference half an hour later) is all about the Fed’s projections rather than whether they raise rates or not. Anything other than a 25bp rate hike would be a huge surprise to the market. Discounting that possibility on the grounds that the Fed is so (too) obsessed with managing market expectations ahead of policy moves, what we’ll watch are the ‘dots’ showing FOMC’s projections of where Fed Funds might go. Market pricing of Fed Funds through 2017- 19 is at the bottom of what the Fed currently projects. Our US economists think that the 2017/18 dots probably won’t move but beyond that, an upward adjustment is possible to send a signal to the market that the FOMC is serious about normalising policy.

Yes, “to send a signal to the market that the FOMC is serious about normalizing policy.” And see that’s the problem. The Fed already tried that. And since March odds converged on 100%, we’ve seen nothing but signs that while this market will probably be willing to write off one hike as a positive development (you know, as confirmation of the reflation narrative’s legitimacy), anything beyond that in terms of an overzealous normalization trajectory could very well trigger a tantrum and undercut oil prices further.

So is the Fed behind the curve? Or, put differently, are we right to fear an FOMC that sees itself as playing catch up? In short, probably. Here’s Goldman:

Exhibit 1 shows the gap between the funds rate and the rule-implied rates. Positive values indicate that policy is “too tight,” while negative values indicate that policy is “too easy.” The results using the HLW estimate of r* imply that policy is just over 1pp easier than the rule-prescribed rate, while the results using a 2% neutral rate imply that policy is almost 3pp easier. Accounting for the impact of the balance sheet would make both gaps moderately larger. The constant neutral rate assumption implies that the current policy stance represents the largest dovish policy deviation since the 1970s, though it is only half as large as the most extreme gaps of the 1960s and 1970s.


If the Fed is behind, what would it take to catch up? Last week, we showed that the Fed’s projections over the next few years already correct the modestly “too easy” stance implied by its depressed r* view. Under the alternative assumption that critics of the low r* thesis are right and a 2% neutral rate is a better guide, current policy is about 3.5pp too easy and the Fed’s terminal rate estimate about 1pp too low, requiring 1 additional hike per year beyond those already planned to catch up by 2020.

Got that? Ok, good.

Overnight, oil was higher following Tuesday afternoon’s API data which, as noted here, showed a surprise draw. Meanwhile, the dollar meandered lower along with rates.


“The yield on 10-year Treasuries slides for a second day and the dollar weakens ahead of the Fed’s announcement on rate decision,” Bloomberg writes, adding that “European bonds are edging higher as Dutch securities outperform ahead of the election outcome, tightening by 1-2bps across the curve vs Germany, after final polls show a last-minute drop in support for anti-European PVV party.”

O/N vol in EURUSD rose above 17 vol from under 7 vol yesterday as it now captures the aftermath of the Fed meeting and the outcome of the elections in the Netherlands.


Here’s some further FX color from Nordea’s Martin Enlund:

And a bit more from Bloomberg:

  • In another sign that traders are exercising calm ahead of the Dutch vote, the difference in yields between the nation’s five-year notes and comparable German debt has shrunk this month.
  • Traders will closely look at how the euro skeptic Freedom Party performs as that could set the tone for populism across the region. Still, election risk remains just that, a risk, which in the case of Marine Le Pen winning the French presidency is a tail one according to polls
    • Meanwhile as the U.K.’s exit from the European Union is real, no matter the timing of its trigger, euro-pound calls traded at their widest premium over puts in seven weeks
  • The euro pared part of its Tuesday losses as the dollar saw opposite fixing-related flows compared with yesterday; the common currency traded just shy of offers within 1.0640-50, traders in Europe said
    • A drop below 1.0600 handle will bring into play more than EU2.3b worth of expiries rolling over at the New York cut-off within 1.0550-75: DTCC
    • Interbank names are still on the bid to fade any additional euro weakness, with a small portion of the orders good-through the Fed decision

Here’s a wrap of Asian and European markets (Europe up to date as of pixel time):

  • Nikkei down 0.2% to 19,577.38
  • Topix down 0.2% to 1,571.31
  • Hang Seng Index down 0.2% to 23,792.85
  • Shanghai Composite up 0.08% to 3,241.76
  • Sensex down 0.01% to 29,440.36
  • Australia S&P/ASX 200 up 0.3% to 5,774.00
  • Kospi down 0.04% to 2,133.00
  • FTSE 7370.47 12.62 0.17%
  • DAX 11989.38 0.59 0%
  • CAC 4973.15 -1.11 -0.02%
  • IBEX 35 9952.50 47.40 0.48%

Futs are green. Watch the EIA data this morning for confirmation of the API draw. And don’t forget CPI at 8:30.

  • 7am: MBA Mortgage Applications, prior 3.3%
  • 8:30am: Empire Manufacturing, est. 15, prior 18.7
  • 8:30am: US CPI MoM, est. 0.0%, prior 0.6%
  • 8:30am: US CPI Ex Food and Energy MoM, est. 0.2%, prior 0.3%
  • 8:30am: US CPI YoY, est. 2.7%, prior 2.5%
  • 8:30am: US CPI Ex Food and Energy YoY, est. 2.2%, prior 2.3%
  • 8:30am: US CPI Core Index SA, est. 251.2, prior 250.8
  • 8:30am: US CPI Index NSA, est. 243.4, prior 242.8
  • 8:30am: Real Avg Weekly Earnings YoY, prior -0.63%
  • 8:30am: Real Avg Hourly Earning YoY, prior 0.0%
  • 8:30am: Retail Sales Advance MoM, est. 0.1%, prior 0.4%
  • 8:30am: Retail Sales Ex Auto MoM, est. 0.1%, prior 0.8%
  • 8:30am: Retail Sales Ex Auto and Gas, est. 0.2%, prior 0.7%
  • 8:30am: Retail Sales Control Group, est. 0.2%, prior 0.4%
  • 10am: NAHB Housing Market Index, est. 65, prior 65
  • 10am: Business Inventories, est. 0.3%, prior 0.4%
  • 2pm: FOMC Rate Decision (Upper Bound), est. 1.0%, prior 0.75%
  • 2pm: FOMC Rate Decision (Lower Bound), est. 0.75%, prior 0.5%
  • 4pm: Total Net TIC Flows, prior $42.8b deficit
  • 4pm: Net Long-term TIC Flows, prior $12.9b deficit

Happy trading.

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