Dreaming of Doves: The Disconnect Between the Market and the Fed
Will the Fed raise rates and if so, when will they start and how quickly will they hike?
In a world obsessed with easy money, these questions have become among the most important for global markets.
There is currently a wide disconnect on the answers, depending on whether we are looking at the Fed’s own projections or the projections implied by the market via the Fed Funds Futures.
The Fed last revealed its expectations (known as “dot plots”) in December, when they projected a year-end policy rate of 1.13% in 2015. This would imply between four and five rate hikes of 25 basis points in 2015 and the first hike to occur in June or July.
Fed Fund Futures today are far from these levels, with the market expecting a year-end policy rate of 0.56%. This implies only two to three hikes in 2015 with the first hike not occurring until September or October.
If we look out further, the expectations gap widens even more, with the market expecting only 1.96% at the end of 2017 versus the Fed’s projections of 3.63%.
Why the large disconnect and how will it be resolved?
Market participants are likely calling the Fed’s bluff here as betting on more dovishness has been the best bet every year since 2009. In 2010 and 2011 when the Fed was expected to hike rates within months, they reversed course after sharp stock market declines.
Most believe the same will happen in 2015 and with the additional pressure of global easing (over twenty central banks have eased policy in the last two months) and the rising dollar, few think the Fed will be the first to act.
Perhaps they will be correct, but I have a different view here. I believe Fed wants to start normalizing and will adjust market expectations as soon as the March 18th meeting. By removing the word “patient” and reaffirming their dot plots from December, they will send a strong message to the market that this time is indeed different and that a June/July hike is possible.
What could derail plans to raise rates in 2015? As I wrote a few months back, a large stock market correction if history is any guide. They cannot serve two masters and they have shown time and again that they will choose the short-term movement of the stock market over the real economy in making policy decisions.
But absent such a correction, the Fed is likely to move.
For as Stan Druckenmiller said on CNBC earlier this week: “If the Fed was ever going to raise rates and not have it dramatically impact financial conditions, this is a golden opportunity right here, right now. Because there’s so much foreign money that I think will be attracted to treasury rates that it will not affect the curve as it traditionally has if the Fed starts moving.”
Will Yellen take this “golden opportunity”? The market still doesn’t believe so, but then again, the market isn’t always right.
This writing is for informational purposes only and does not constitute an offer to sell, a solicitation to buy, or a recommendation regarding any securities transaction, or as an offer to provide advisory or other services by Pension Partners, LLC in any jurisdiction in which such offer, solicitation, purchase or sale would be unlawful under the securities laws of such jurisdiction. The information contained in this writing should not be construed as financial or investment advice on any subject matter. Pension Partners, LLC expressly disclaims all liability in respect to actions taken based on any or all of the information on this writing.
CHARLIE BILELLO, CMT
Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts. He is the co-author of two award-winning research papers in 2014 on Intermarket Analysis and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors, an institutional investment research firm. Previously, Mr. Bilello held positions as an Equity and Hedge Fund Analyst at billion dollar alternative investment firms, giving him unique insights into portfolio construction and asset allocation.
Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and a Member of the Market Technicians Association. Mr. Bilello also holds the Certified Public Accountant (CPA) certificate.
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