April FOMC Minutes Put June Hike Back On Table

First it was the April FOMC statement that turned out to be more dovish than hawkish, and then it was the April NFP report that missed expectations badly, busting market expectations for a June rate hike.

Ever since the release of the April FOMC statement, the market-implied probability for a June hike had crashed to a low of 4%, as traders and market participants heavily discounted for what we call a "hawkishly-dovish" Fed, and on the heels of broad misses in U.S. macro, the prospect for a June hike diminished. No surprise here, but read on.

However as regular readers and subscribers to our journals will know, we believed that despite soft economic data and cautious/dovish Fed language, there was still a good chance for a Fed hike in June. The tides turned this week upon the release of the April FOMC minutes, and very abruptly so.

Hawkish turn by the Fed

A hawkish turn was something we warned about in the preceding days before the release of the April Fed minutes. It was also one of the risks we highlighted here, and here, under uncertainties regarding monetary policy.

April's FOMC minutes seemed to have revived the market's appetite to be long the U.S. dollar against risk, and certainly against the precious metals, with the latter seeing some of their best gains in almost 2 years, again on the heels of a weakening dollar bolstered by the market's sentiment that the Fed will hold off hike rates until later in the year.

  "April FOMC minutes: Fed likely to hike rates in June should data improve.    Dollar is higher post release.    Bulletin headlines:    MOST FED OFFICIALS SAW JUNE HIKE `LIKELY' IF ECONOMY WARRANTED    FED: RANGE OF VIEWS ON WHETHER DATA WOULD SUPPORT JUNE HIKE    FED: MANY OFFICIALS NOTED GLOBAL RISKS NEED `CLOSE MONITORING'    FED: OFFICIALS WANTED TO KEEP `OPTIONS OPEN' FOR JUNE    Key pointers:    Most participants judged that if incoming data were consistent with economic growth picking up in the second quarter, labor market conditions continuing to strengthen, and inflation making progress toward the Committee’s 2 percent objective, then it likely would be appropriate for the Committee to increase the target range for the federal funds rate in June.    Many participants noted that downside risks emanating from developments abroad, while reduced, still warranted close monitoring. For these reasons, participants generally saw maintaining the target range for the federal funds rate at ¼ to ½ percent at this meeting and continuing to assess developments carefully as consistent with setting policy in a data-dependent manner and as leaving open the possibility of an increase in the federal funds rate at the June FOMC meeting.    Some members expressed concern that the likelihood implied by market pricing that the Committee would increase the target range for the federal funds rate at the June meeting might be unduly low.    Many participants noted that downside risks emanating from developments abroad, while reduced, still warranted close monitoring.    Regarding the possibility of adjustments in the stance of policy at the next meeting, members generally judged it appropriate to leave their policy options open and maintain the flexibility to make this decision based on how the incoming data and developments shaped their outlook for the labor market and inflation as well as their evolving assessments of the balance of risks around that outlook.    Some participants noted that global financial markets could be sensitive to the upcoming British referendum on membership in the European Union or to unanticipated developments associated with China’s management of its exchange rate.    A few cited concerns about rapidly rising prices of CRE, including multifamily properties, or about illiquidity of the assets of some mutual funds."    Business Of Finance on Facebook, 18 May 2016

"April FOMC minutes: Fed likely to hike rates in June should data improve.

Dollar is higher post release.

Bulletin headlines:

MOST FED OFFICIALS SAW JUNE HIKE `LIKELY' IF ECONOMY WARRANTED

FED: RANGE OF VIEWS ON WHETHER DATA WOULD SUPPORT JUNE HIKE

FED: MANY OFFICIALS NOTED GLOBAL RISKS NEED `CLOSE MONITORING'

FED: OFFICIALS WANTED TO KEEP `OPTIONS OPEN' FOR JUNE

Key pointers:

Most participants judged that if incoming data were consistent with economic growth picking up in the second quarter, labor market conditions continuing to strengthen, and inflation making progress toward the Committee’s 2 percent objective, then it likely would be appropriate for the Committee to increase the target range for the federal funds rate in June.

Many participants noted that downside risks emanating from developments abroad, while reduced, still warranted close monitoring. For these reasons, participants generally saw maintaining the target range for the federal funds rate at ¼ to ½ percent at this meeting and continuing to assess developments carefully as consistent with setting policy in a data-dependent manner and as leaving open the possibility of an increase in the federal funds rate at the June FOMC meeting.

Some members expressed concern that the likelihood implied by market pricing that the Committee would increase the target range for the federal funds rate at the June meeting might be unduly low.

Many participants noted that downside risks emanating from developments abroad, while reduced, still warranted close monitoring.

Regarding the possibility of adjustments in the stance of policy at the next meeting, members generally judged it appropriate to leave their policy options open and maintain the flexibility to make this decision based on how the incoming data and developments shaped their outlook for the labor market and inflation as well as their evolving assessments of the balance of risks around that outlook.

Some participants noted that global financial markets could be sensitive to the upcoming British referendum on membership in the European Union or to unanticipated developments associated with China’s management of its exchange rate.

A few cited concerns about rapidly rising prices of CRE, including multifamily properties, or about illiquidity of the assets of some mutual funds."

Business Of Finance on Facebook, 18 May 2016

As we've included in the chart above, April's FOMC minutes was rather divergent from the much more dovish and cautiously played statement. In short, FOMC members stated that June's meeting would be a live one, meaning members would have to make fresh decisions on interest rates. The Fed will remain data dependent, and will likely monitor recent weakness in the jobs markets (NFPs, weekly claims, and wage inflation).

  "The aftermath post April's FOMC minutes: Stocks down (risk off), USD strength (as we forewarned), yield curve flatter (rate hike discount), gold down (again, as we forewarned).    Most importantly, June rate hike odds per the FF futures market is currently above 30%, from lows of 4% immediately after 28 April's FOMC statement.    Still, too early to say "told ya so", more waiting. Portfolio long USD exposure doing well."    Business Of Finance on Facebook, 18 May 2016

"The aftermath post April's FOMC minutes: Stocks down (risk off), USD strength (as we forewarned), yield curve flatter (rate hike discount), gold down (again, as we forewarned).

Most importantly, June rate hike odds per the FF futures market is currently above 30%, from lows of 4% immediately after 28 April's FOMC statement.

Still, too early to say "told ya so", more waiting. Portfolio long USD exposure doing well."

Business Of Finance on Facebook, 18 May 2016

Importantly, the minutes stressed that the Fed believed markets had underestimated its propensity to hike rates, and had grossly underpriced such a possibility (this is obvious given how low the FF futures implied probability of a June hike fell before the minutes were released).

By directly addressing market expectations, we feel the Fed is trying to manage expectations to what they might do in the future. This has always been a key ingredient to the relative success of the Fed. By varying its language, we believe the Fed is bent on taming market volatility when it does make a decision on interest rates come June.

  "It's good to be right again. This time, we were right about just about everything we were expecting. Yesterday's release of the April FOMC minutes cemented the strong dollar (weak everything else) trend for the short term, leading to a strong selloff in the precious metals complex, with silver crashing during Thursday's trading and gold following suit.    We published an article titled " Sell In May & Play it Safe " this past Sunday, where we advocated derisking, and staying liquid (buy cash, safety, and shun risk). We also commented that should technical factors align, we would be willing sellers of the precious metals. In short, we had already turned bearish risk, gold, oil and most commodities, while bullish the U.S. dollar. We couldn't be more right.    To wit ( full article here ):    "downside skews in risks make a derisking maneuver potentially more rewarding than chasing beta...    As such, we have shifted our bias to the short side of risk. The positions in our portfolio have partially reflected this change in view and will continue to do so as the situation evolves.    ... on a beta-adjusted basis, we expect equities, precious metals, and the dollar (USD FX crosses) to be hit the hardest. A highly levered play would be to short the PMs on momentum...""    Business Of Finance on Facebook, 18 May 2016

"It's good to be right again. This time, we were right about just about everything we were expecting. Yesterday's release of the April FOMC minutes cemented the strong dollar (weak everything else) trend for the short term, leading to a strong selloff in the precious metals complex, with silver crashing during Thursday's trading and gold following suit.

We published an article titled "Sell In May & Play it Safe" this past Sunday, where we advocated derisking, and staying liquid (buy cash, safety, and shun risk). We also commented that should technical factors align, we would be willing sellers of the precious metals. In short, we had already turned bearish risk, gold, oil and most commodities, while bullish the U.S. dollar. We couldn't be more right.

To wit (full article here):

"downside skews in risks make a derisking maneuver potentially more rewarding than chasing beta...

As such, we have shifted our bias to the short side of risk. The positions in our portfolio have partially reflected this change in view and will continue to do so as the situation evolves.

... on a beta-adjusted basis, we expect equities, precious metals, and the dollar (USD FX crosses) to be hit the hardest. A highly levered play would be to short the PMs on momentum...""

Business Of Finance on Facebook, 18 May 2016

The market's reaction to the April minutes was unsurprising to us. As the charts above illustrate, dollar strength was the main driver on the day, and we suspect this might continue in the coming days or even weeks. When the greenback fell precipitously from their 2016 highs, we warned that the markets were getting ahead of reality, and that there was a good chance they have misread the Fed. The fierce counter moves we saw in the pays few days are proof of this.

Anti-dollar assets, chiefly the precious metals, were hit exceptionally hard following the minutes. The FF futures implied probability of a June hike spiked from the 4%-10% range to 30% currently. Treasury yields were volatile but seem to be relatively indifferent about this repricing of risk. This is clearly a strong dollar weak dollar trade at play.

Interestingly, Eurodollar futures (chart below) had been discounting for higher money market rates since the middle of May, diverging from the weakness in the dollar (lower/unchanged rates, dovish policy) and strength in treasuries relative to equities. We encourage traders to eye Eurodollar rates and prices because they are usually the most sensitive even to micro shifts in sentiments at the highest tiers. 

  "We're now 5 minutes away from the release of April's FOMC minutes, where the market will be scrutinizing every word of the document for any hints of what the Fed may do during the upcoming June meeting.    Here, we have the price chart of the September Eurodollar future contract (not EURUSD). Eurodollars are money market rates; future prices rise when rates fall and vice versa.    During the last week or so, Eurodollars have fallen hard, which implies a greater discount on higher FF rates. This is after a strong rally post the April FOMC meeting which yielded no hike.    What happens next? More chop perhaps."    Business Of Finance on Facebook, 18 May 2016

"We're now 5 minutes away from the release of April's FOMC minutes, where the market will be scrutinizing every word of the document for any hints of what the Fed may do during the upcoming June meeting.

Here, we have the price chart of the September Eurodollar future contract (not EURUSD). Eurodollars are money market rates; future prices rise when rates fall and vice versa.

During the last week or so, Eurodollars have fallen hard, which implies a greater discount on higher FF rates. This is after a strong rally post the April FOMC meeting which yielded no hike.

What happens next? More chop perhaps."

Business Of Finance on Facebook, 18 May 2016

Concluding

We still stick to our prognosis that a June rate hike is on the table, despite what the overall market believes. The gist of the matter is that markets usually overshoot reality and will therefore get things (such as monetary policy decisions) wrong. We might be in one of such cases.

We will be watching how the U.S. dollar and related assets perform in the coming days and weeks. We see more dollar strength ahead as short dollar positions will likely be forced to cover as the market renormalizes in time for the June FOMC statement and rate decision.

On risk, we are on the fence for American equities but are ready to turn on a dime should technical factors align. We expect volatility to be concentrated in commodities and FX. Other than that, all eyes will be on the coming May NFP (first week of June), and the June FOMC rate decision.