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An FOMC 30 for 30: What if I told you that removing “patient” doesn’t mean we are going to be impatient?

What if I told you the Philadelphia curse extends to colleges?

No matter how many 30 for 30’s ESPN trots out, you can’t make me yearn for the Laettner era Bill Simmons! Maybe he should turn his attention to Philadelphia, because picking Nova for the Final Four is like saying the Fed isn’t going to hike this year – it’s a losing proposition. I don’t even feel bad for you at this point if you are on that side of either trade. I grew up a Philly fan so I would love to see Nova do well, but they are the Peyton Manning of college hoops. Or for you SEC fans, they are the South Carolina football of college hoops. Don’t bet on them when the stakes are high.

What if I told you that removing “patient” doesn’t mean we are going to be impatient?

Yellen delivered a dovish message Wednesday, basically confirming the timing of the first hike while suggesting the path to “normalization” will be a gradual one. This reinforces our expectations that a hike is coming, but that it also won’t be a typical tightening cycle.

“Just because we removed ‘patient’ doesn’t mean we are going to be impatient,” Yellen said, trying to avoid a market shock as much as possible. The official statement was more hawkish than markets think, so we think the reaction was overdone. But, just as importantly, the Fed’s blue dots forecast for Fed Funds showed a drop across the curve of about 0.50%, even more than we suggested in our last newsletter. This helps close the 1.00% gap between Fed forecasts and market expectations, but still leaves a discrepancy of 0.50%+. We don’t think the Fed will decrease the forecast again materially, which means rates would have to move up half a point.

Last week we suggested that the FOMC could use the blue dots forecast as a way to signal the market outside the scope of the official statement. “Blah blah blah blah official stuff here and there” and then sneak in the “hey, you guys should probably pay attention to this stuff over here…” Call us if you need help translating that highly technical analysis, but the market was largely reacting to the Fed blue dots, not the statement itself. That means a change in blue dots in the future could have an opposite reaction and push rates higher.

Rates plunged across the curve while equities rallied. “The Fed is as accommodative as an NCAA referee calling one of our games!” said Coach K in an interview with the WSJ. The 10yr ran down to 1.93% following the news. The belly of the curve saw an even bigger move, with 5yr rates down 0.17%.

But she also indicated that every meeting is a live one and a hike could come at any meeting. Although I hate to beat a dead horse, the message is the same as it has been for quite some time – the Fed is hiking soon but it will be a gradual hike.

What if I told you 1 month LIBOR can actually move?

It’s been so long since the Fed changed Fed Funds, let’s spend a moment talking about how LIBOR responds. Traditionally, 1 month LIBOR resets about 0.07% – 0.12% above FF. If FF is 0.25%, 1mL would be around 0.32% – 0.37%.

LIBOR also prices in expectations for hikes/cuts ahead of Fed meetings, so it will move ahead of the FOMC meeting. A 100% probability of a hike to 0.25% and a 25% probability of a hike to 0.50% would typically push 1mL to around 0.375% – 0.42% ahead of the Fed meeting. If the FOMC hiked to 0.25%, then 1mL would dip a bit and settle in around 0.32% – 0.35%.

But this cycle is going to be different in that the Fed has suggested it will hike using a range instead of a precise target. For example, the first hike this year will likely be to 0.25% – 0.50%. What does that imply for LIBOR and your floating rate borrowings?

No one knows. And if they say they do, ask them how their bracket is doing. They are probably one of those guys that has only missed one game and it was because they had Ga State beating Xavier “because I watched Ga State earlier this year on the Ocho and knew they were for real.” I can’t stand That Guy.

But, as long time readers of this newsletter can attest, lack of insight has never prevented us from speculating. And we certainly aren’t going to start today.

Assuming the Fed hikes to 0.25% – 0.50%, I would guess 1mL starts climbing in May because Yellen said an April hike was a low likelihood. But June is in play, so 1mL will start pricing in a hike heading into that meeting as long as the Fed keeps it on the table. The higher the likelihood of a hike, the higher LIBOR will move ahead of the meeting.

I suspect 1mL will move to around 0.35% – 0.40% and 3mL will move to around 0.50% – 0.55%. You should expect your floating rate invoices to start moving higher in May/June. Tell your controller there isn’t anything wrong with the billing, it turns out floating rates can actually move around.

For those of you that have been treating LIBOR as a fixed rate, those days are over…temporarily. I still think the Fed will get to some level (0.75% – 1.00%) and then pause for quite some time, but there will be some recalibration on the way up.

What if I told you this week would be a quiet one?

Very little domestic data this week, but quite a few Fed speeches scheduled to help reinforce/clarify last week’s message, starting with Monday’s speech by Stanley Fischer called “Monetary Policy Lessons and the Way Ahead”. Then Yellen closes the week on Friday at an SF conference called “The New Normal for Monetary Policy.” You think maybe they are trying to let the market know what Fed policy is going to look like during the upcoming tightening cycle?

Expect Yellen’s message to be the same as her Q&A prepared statement. The dovish FOMC members will highlight global headwinds, strengthening dollar, lower oil prices, etc as potential reasons to delay on a hike. The hawks will mention the labor market and falling behind the curve. The messages will roughly balance each other out and allow the Fed to remain data-dependent in the coming months.

What if I told you this newsletter is done because I’d rather watch hoops than talk rates?

 

Click to Open: THE PENSFORD LETTER PDF

The Pensford Letter – 3.23.15