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Misreading the Fed and Interest Rates

​The FOMC is unusually unified in their message of normalizing policy rates sooner rather than later. This is a clear sign, in our view, of their strong resolve to go forward with plans for two more rate hikes this year and balance sheet reduction next year.

Markets, however, remain unconvinced. In the past, it has been wise to bet against the Fed’s resolve. When markets and the Fed disagreed it was the FOMC that would blink first and converge with market expectations. That is no longer the case and there are three key implication of this disconnect:

1.) ST rates: Markets underestimate Fed’s resolve for additional rate hikes

In our view, the FOMC will need clear and compelling reasons to not deliver on their forecast of two rate hikes this year.

2.) Fed has an enormous communication challenge with balance sheet reduction

The Fed wants to convince markets they are firm in their resolve to embark on this next stage of policy normalization. Yet ,they do not want to be so strident in their rhetoric that they induce a sharp price movement like the Taper Tantrum of 2013.

3.) LT rates: Potential to move higher as Fed demand dissipates

The longer markets wait to embrace this next stage of normalization, the greater the potential for an abrupt – rather than gradual - price movement.