Yesterday Nomura – rather intentionally – caused a trading desk stir when for the second time it became the first bank to call for a 100bps rate hike (it was wrong the first time). That, together with an article by Fed mouthpiece Nick Timiraos, briefly pushed 100bps hike odds to just shy of 50%. Today, however, the pushback has begun, and JPMorgan’s chief economist Michael Feroli just published a note in which he says that “the odds of a 100bp move– though certainly not zero–are lower than 1/3rd.”
Some more details from the full note available to pro subs:
We think the case for a move larger than our expected 75bp is reasonable, though we also saw that case in prior meetings and for whatever reason the FOMC chose to get to where they’re going in a series of smaller moves. With that decision having been made earlier in the year, good drivers don’t increase their speed as they get closer to their destination.
Of course that destination is a moving target, but for it to be farther away now than it was in June–when they chose the current 75bp tempo–would imply the Committee has a terminal funds rate expectation greater than 5.0%, which we doubt.
More important than whether we get 75bps or 100bps, however, is what the Fed’s new terminal rate will be as it has far greater weight in valuation models, and following yesterday’s CPI many now expect the steady-state rate to be around 4.50%-4.75%.
This brings us to the topic of the dots, which according to Feroli, will have an interesting interaction with both the size of next week’s hike and the statement’s forward guidance. Relative to the last set of economic projections made in June, this year’s GDP outlook is tracking lower than their median forecast, unemployment is running spot on, headline PCE inflation is tracking lower, and even after yesterday the core PCE inflation outlook may be tracking a little lower.
On the face of it, he says, this wouldn’t argue for a material upward revision to the dots for year-end ‘22, and “even taking that into account it may be hard to get the median dot which was 3.5% in June (upper bound of the range) to much above 4.0%.”
Finally, there is the actual statement, which is important because the FOMC Committee perceives it – and not the dots – as their chief communication tool. The crucial phrase in the most recent statements has been “ongoing increases in the target range will be appropriate.” As the FOMC gets closer to their expected terminal rate, Feroli predicts that this language will need to be softened some, to perhaps “likely be appropriate.” Still, since the Fed does not want to send a dovish signal, this should be paired with language that a restrictive stance of policy will be warranted for some time.
Pushing back against expectations of easing next year is not merely a matter of aligning forecasts, but rather of exerting more influence over longer-term interest rates: basically the opposite of the “low-for-long” strategy that many market participants have been raised on.
In this regard, Feroli concludes, “a 100bp move next week may only encourage those who see easing next year following a Fed accelerating hikes in late ‘22.”
Of course, JPM’s statement may seem provocative…until one checks the current market pricing and finds that STIR traders currently give just 24% odds to a 100bps rate hike next week, below JPM’s “one third.”