Pre-FOMC: Time To Hike – SEB

LIFTOFF ALMOST GUARANTEED. In all likelihood, the Fed will raise the fed funds rate by 25 basis points thus taking the target range to 0.25-0.50 per cent at the meeting that concludes on 16th December. Markets are pricing in a very high probability of liftoff; while the chance of a 25 basis point hike is 76 per cent according to futures the hike may well be fully priced since a 25 basis point hike may actually raise the Fed funds rate by less due to excess liquidity in the system. Most Fed watchers see liftoff too; only 3 of 101 expect unchanged interest rates according to a Bloomberg poll.

UNANIMOUS DECISION? While Chair Yellen certainly would like a unanimous decision at such an important meeting, she may not get it her way. In our view it is Chicago Fed’s Charles Evans who is the most probable dissenter, but since he will not have a vote in 2016/17 the implications for future policy would be minimal. Evidently, Fed governors Tarullo and Brainard are leaning in dovish directions too but neither of them has actually dissented in the past. It is also good to know that while Governors voting against the majority are not unprecedented, one has to go all the way back to 2005 to find the last time that happened. Evidently the dovish Minneapolis Fed’s Kocherlakota, who most likely was the one who wanted a negative Fed funds rate back in September, will not attend the December meeting and will be a non-voter in 2016.

DOVISH PRESS CONFERENCE. At the press conference we expect the Chair to provide a dovish message further underlining the gradual nature of this tightening cycle – which stands in sharp contrast to the “measured pace” language and the series of hikes in 2004-2006 for example. To further back up that message, it is our impression that markets are looking for cuts in the median Fed projections to, say, 1.125 per cent by end-2016 and 2.375 per cent by end-2017. But in our view the surprise potential here is for unchanged dots, at least as far as 2016 is concerned. While markets initially may respond negatively to largely unchanged dots, in our view the press conference is much better suited to get the dovish message across in any event. Look, the dots are not known by the Chair in advance since they are submitted before the meeting begins and as such they are not reflecting any consensus-building efforts.