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3 Scenarios of This Fed Meeting and Their Implications

3 Scenarios of This Fed Meeting and Their Implications

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By    |   Tuesday, 13 December 2016 04:36 PM

 

Looking at the futures market for the fed funds rate (i.e., real money betting on the binary outcome of whether the Fed will raise rates after its next meeting on December 13 and 14), we can see the traders are now overwhelmingly betting on a 25-basis-point hike from its current range of 25–50 bps.

And by overwhelmingly, I mean 97.2% of traders are now betting on a 0.25% hike.

Of course, there is the possibility that the Fed gives in to the hawks—or tries to wrong-foot Trump—by raising rates more aggressively. Say by 50 bps. Or it could simply leave them where they are.

However, those two scenarios must be viewed as outliers.

The point I am trying to make is that the market has already fully priced in a 25-basis-point Fed hike in December. But, importantly, betting on a hike of such a diminutive size is a short-term trade, not a bet on a long-term trend change.

Three possible scenarios

That suggests the following market action could result:

  • The Fed announces a 25 bps hike. The phenomenon of “Buy on rumor, sell on news” kicks in and Treasury yields, which have spiked over 3% on the 30-year bond, a 50-basis-point jump over the last month, begin to retrace the increase. To speculate on this scenario, you could buy a long-Treasury ETF such as TLT, which gives you a solid shot at profiting as the traders take profits. Few will expect the Fed to continue to raise rates aggressively in 2017, or at least to the degree that would represent a major trend change.
Per other recent articles in this service, historic levels of government, corporate, and personal debt serve as a physical cap on interest rates. Simply, rates can’t rise very much because the beginning of a secular rise in interest rates would mean the end of well, everything.
  • The Fed announces a 50 bps hike. In this case, the stock market will crash. And historically, when stocks crash, money pours back into bonds, meaning yields will come down. Maybe they’ll go up a bit first, but in the end TLT will still likely turn out to be a profitable trade as there is little question it has run up too far, too fast in recent weeks. Again, the odds of this happening—at least according to traders—are effectively zero.
  • The Fed announces it will leave rates where they are. In that case, a mad scramble for the exits by the traders with bets on higher rates will ensue. Treasury yields will quickly retrace and probably overshoot on the downside… again making TLT a great trade.

For the record, I am pasting in a snapshot of the price action in TLT over the course of 2016. You can see just how far and fast yields have risen in the second half of the year (which translates into the fall in prices shown in the chart).

At the bottom of the chart, you can also see that the negative momentum is starting to wane, suggesting a bottom may be close.

I wouldn’t wait overly long before getting positioned.

A reasonable bet

There is no such thing as a sure thing when it comes to this sort of speculation. However, in the absence of a serious trend change in the direction of interest rates, and given the baked-in-the-cake expectation that the Fed will raise rates by 25 basis points next week, I think placing at least a small wager that Treasury bill rates will fall after the announcement seems like a reasonable speculation.

(If you want a sure thing, focus your attention on buying great companies when they fall to a level of deep undervaluation. How to do just that is explained in some detail in our free report, Dimes for Dollars—The 3 Most Powerful Strategies to Buy Low and Sell High).

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The market has already fully priced in a 25-basis-point Fed hike in December. But, importantly, betting on a hike of such a diminutive size is a short-term trade, not a bet on a long-term trend change.
fed, rate, meeting, yellen
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2016-36-13
Tuesday, 13 December 2016 04:36 PM
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