Over the past couple of weeks the Fed has worked hard to manage the market’s expectations with regard to the timing of the first interest rate hike since the collapse of 2008. Many Fed members have re-affirmed that the October 28th Fed meeting remains a “live” event, which is Fed speak that translates to: a likely candidate for a hike. However, since then, the economic data has been lack luster and the most recent Fed speakers have taken on a different tone in their communique. Market participants have doubted the overall likeliness of a hike this year, whether it be at the Oct 28th Fed meeting or at the Dec 16th Fed meeting, and are currently in disagreement with the Fed over the terminal rate projected at their Sep meeting for the long-run, which has made flattener trades active throughout the curve.

Looking into the most recent and important data points in the US, there doesn’t appear to be evidence to support an October hike. Manufacturing surveys have been weak across the board for September. The dual ISM reports arrived slightly below expectation, Chicago and Philly Fed arrived substantially below expectations at 48.7 vs 53.2 (exp) and -4.5 vs -1.8 (exp) respectively. The latest Empire State Manufacturing number, our first glimpse into October manufacturing activity, arrived quite weak at -11.4 vs 7.3 (exp) and may serve to dial expectations lower for upcoming manufacturing reports for the month of October.
Inflation numbers this month have been benign at large, Core PPI arrived at -0.3% m/m vs 0.1% (exp) in line with an annualized pace of 0.8%, demonstrating a continuation in the downward trend in producer prices. Core CPI numbers ticked up to 0.2% m/m vs 0.1% (exp), commensurate with a 1.9% annualized rate, which has been inching towards the Fed’s 2% target.

Weekly unemployment claims surprised markets this week with a significant downtick to 255K vs 269K (exp), to match the lowest level since 1973. Equity markets rallied on the back of the figure and amongst some strength observed in commodity markets. The S&P closed off the week at 2013.0 from 1990.0 lows just before the print. This was not just an ordinary weekly claims print, as suggested by the reaction in the US market place just after the release. The employment situation has looked grim for some time with the last Payrolls print arriving exceptionally weak at 142K vs 205 (exp), and this is the first piece of overwhelmingly positive employment data since the beginning of the month. It was also survey week for the Nov 6th Non-Farm Payrolls release, which may have caused some participants to place extra emphasis on this week’s release. Though it should be dually noted that next week’s claims number coincides with the payrolls survey data, as the claims data is lagged by a week.

This week’s Fed commentary was “dovishly-hawkish”, on balance. This terminology may seem confusing as well as oxymoronic, however the terms “dovishly-hawkish” and “dove-hike” expediently and accurately describe the market’s overall take on the Fed’s likeliness to maintain accommodative policy after the first rate lift-off and their proclivity to walk on eggshells as they time it. In contrast to prior weeks, wherein the majority of Fed communications reinforced that October remains a “live” target for the first interest rate hike, this week’s Fed speakers were more cautious on the whole.

Fed’s Brainard (2015 Voter, Dove) called for no rate hike until downside risk to economy subside, and alluded to wage growth issues despite employment growth and that inflation in short term is tilted to downside. Fed’s Tarullo (2015 Voter, Dove) reinforced that it remains appropriate to hike 2015, but also did not comment on Oct as being a rate lift-off target. Fed’s Lacker (2015 Voter, Hawk) remains uncertain to whether or not rates go up at this month’s Fed meeting, but talked down the importance of that morning’s weak Retail Sales print ( Core Retail -0.3% vs 0.1% exp), in the Fed’s overall decision process. Fed’s Bullard (Non-Voter, Hawk | 2016 Rotation) explained that it will be “difficult to hike Oct” with only one month extra of data, and that the Fed will remain “exceptionally accommodative” post a hike whenever it may be. As expected, the most dovish Fed member Evans (2015 Voter, Dove) repeated his stance that a delay until mid-2016 for a hike remains the best choice going forward, even though the Fed’s labor market criteria for a hike has been met. Fed’s Lockhart (2015 Voter, Neutral) said that Oct is “live”, the FOMC will receive enough data to make a decision this month, and reinforced that the US does not have a high risk exposure to Chinese economy. The Fed’s Arch-Hawk Mester (Non-Voter, Hawk | 2016 Rotation) explained that the economy needs only 70-120K /month jobs growth to sustain unemployment rates, the US can “handle” an interest rate hike, and that 0 rates can weaken stability but did not comment on the timing of the first hike. Fed’s Dudley (2015 Voter, Dove) approves a 2015 Hike, but only if economy is in-line with Fed forecasts, but did not mention any preference for an Oct Fed meeting hike. There appears to be a divide In the Fed, and while many members can foresee a hike this year, virtually none have pointed to an Oct rate lift-off with any substantial conviction.

The probability of a Fed hike has come-off this week. As implied by the OIS curve, the likeliness of a 25bps hike at the Oct 28th Fed meeting have tumbled to just 4% compared to 16% from last week. Market participants are currently not anticipating any policy action to take place at the Oct Fed meeting, and expectations for a hike before the year’s end have also fallen to just 32% from 48% last week. The Implied Fed Funds Rate curve has flattened substantially as traders doubt the Fed’s “Oct-live” rhetoric from previous weeks. The terminal rate for Sep 2018 flattened 20bps to 1.4% offside by a wide margin from Fed projections of 3.5%, which were published at their Sep 17th meeting.

There are only two weeks remaining until the Oct 28th Fed verdict is rendered and there are very few significant upcoming data points before then which are likely to strengthen the case for an Oct Fed hike. Traders will be looking out for housing data over the next couple of weeks; Housing Starts, Existing Home Sales, and New Homes Sales numbers are up to bat. There are several Fed speakers on the docket early next week before the pre-FOMC meeting communication blackout period. There will be commentary on Monday from Fed’s Brainard (2015 Voter, Dove) and Lacker (2015 Voter, Hawk), Tuesday Fed’s Dudley (2015 Voter, Dove), Powell (2015 Voter, Neutral) and Chair Yellen (Fed Chair, Neutral).

-David Felkai Uptick GMA.

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