The Fed’s Perception Problem (and why it’s Hawkish)
The Fed’s Perception Problem (and why it’s Hawkish)
If the FOMC does indeed become incrementally more “hawkish” today, it’ll likely be because of the growing fear among Fed officials that the market views the Fed as simply being too “dovish.”
We’ve heard several Fed presidents reference this, and last week there was a San Francisco Fed paper citing this potential problem.
And, the worry that the market doesn’t “believe” the Fed isn’t some general “feeling” – it’s actually backed up by hard data.
Fed Funds futures, which trade on the CME and can be accessed via this link, reflect the market consensus of where the Fed Funds rate will be at the end of each month. And, simply put, the market is reflecting a much more dovish Fed than what FOMC members are stating.
The Fed Funds futures prices shows a much slower and more gradual increase in interest rates than the official Fed projections – plain and simple. And, frankly, this type of discrepancy is significant.
And, it’s a problem for the Fed.
If the Fed isn’t being taken seriously (as a hawk) then that poses a potentially serious problem. While the Fed wants to start to restrain the risk-taking and the unbridled “chase for yield” it’s manufactured over the past several years, if the market doesn’t believe the Fed will actually raise rates, then the excessive risk-taking will continue—potentially resulting in bubbles.
Point being – there is some room here for the Fed to give the markets a bit of a “hawkish” dose of reality today – if not via the removal of “considerable time,” then via other means, including the “dots” as we described yesterday, or via Yellen’s press conference.
Point being, the propensity for the Fed to give us a “hawkish” surprise is rising. While that won’t guarantee the bond declines will continue in the near term, the simple fact is that the setup is for the Fed to, finally, be slightly more hawkish. That is, until the market, as reflected by Fed Fund futures, starts to believe rates will rise sooner than is currently the consensus.
Finally, I’ve mentioned frequently that the pace of the increase in rates is more important than the date rates start to rise. You can monitor both via Fed Fund futures (or you can just let us do it … we’re watching it either way). The way it works is you subtract Fed Fund futures from 100 to get the implied Fed Funds rate. So, right now the market anticipates the first rate increase to occur in June 2015 – and if that changes tomorrow, one way or the other, Fed Funds futures will let us know.