Updated: 07-26-2016

The Federal Open Market Committee (FOMC) convened today for a two-day meeting that will culminate with the issuance of a new policy directive on Wednesday at 2:00 p.m. ET.

The market is close to unanimous in its thinking that the FOMC will not raise the fed funds rate.   That view is rooted in the following factors:

  • The fed funds futures market is pricing in only a 3.6% probability of a rate hike at the July meeting.  
  • Market participants know the Fed has no intention of rocking the capital markets now with what would be the mother of all rate hike surprises
  • The spread between the 2-yr note and the 10-yr note has narrowed ten basis points (to just 80 basis points) since the time of the June 15 policy decision
  • The Brexit vote on June 23 unleashed a new layer of uncertainty that Fed officials will want to take added time to see how it plays out in the data
  • The U.S. Dollar Index (and the Fed's Broad Trade-Weighted Exchange Rate Index) has strengthened in the wake of the Brexit vote, providing some de facto tightening pressure already
  • Oil prices have fallen nearly 15% since the Brexit vote

There is some building chatter, however, that the Fed will issue a directive that implies it may very well defy market expectations and raise rates at least once, if not twice, before the end of the year.  At the moment, the fed funds futures market doesn't place a greater than 50% probability on another rate hike until the February 2017 meeting.

Part of that outlook is tied to the belief that the Fed won't raise rates in front of the presidential election (Nov. 8), so as not to risk looking political with its policy action.  Any hawkish-sounding talk from the Fed, then, will be interesting to hear. The question is, will the market really believe it?

Time will tell, yet the factors playing into any hawkish-sounding mindset from the Fed would include the following:

  • The quick recovery in global equity markets after the Brexit fallout, highlighted by the Dow and S&P 500 hitting new record highs
  • The 287,000 gain in nonfarm payrolls in June
  • The marked improvement in high-yield spreads
  • Core CPI, which excludes food and energy, edging up to 2.3% on a year-over-year basis from 2.2% in May
  • Average hourly earnings growth in June increasing 2.6% year-over-year, matching the highest growth rate seen since July 2009
  • A bevy of incoming data recently that has been stronger than expected
    • Retail Sales, existing home sales, new home sales, housing starts, industrial production, ISM Index

The Fed won't raise rates on Wednesday.  However, it may just raise the bar for holding to its accommodative stance, because we suspect the Fed is going to want to keep the market in check with its complacency about the rate hike outlook.  

If it doesn't, the hesitation on the part of buyers in the stock market this week could give way to the resuscitation of animal spirits.

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