Month: September 2015

Tomorrow’s FOMC will almost certainly bring in some excitement. While the prevailing opinion and market pricing seem to be no hike on Thursday, there is still a healthy degree of uncertainty priced in. Consequently:

The short end of interest rate curve will HAVE to move one way or another.

Be careful about trusting the odds of hiking calculated from Fed funds and Eurodollar futures. Correct pricing would incorporate various risk premiums and technicals which can muddy up result.

In this post, I will not argue with the approximate odds offered by the market. We all know the pros and cons. As a sidenote, the best pro I’ve seen is “the avalanche patrol argument” http://markdow.tumblr.com/post/116263207105/the-federal-reserve-on-avalanche-patrol by @mark_dow.

In the past, when I used to bet heavily of the FOMC outcomes, I tended to “favor” the “favorites”, i.e. I believed that whenever there was a more likely outcome the probability of it happening was EVEN HIGHER than projected, because the Fed didn’t like to rattle the market.

But now we have a new Fed and an unprecedented rates situation. I am not ruling out a hike with a dovish language. So I have no position on October Fed Funds futures.

The only meaningful bias I have with regards to the short-term Fed path is that the first hike is unlikely to be in December. There is the economic data lag I have been anecdotally observing over many years, but have no rigorous study to support with. I have noticed that periods of stock market correction and increased volatility tend to be followed with negative economic data surprises with a 2-3 month lag. And if the Fed don’t have in them to hike tomorrow, softer data this fall is unlikely push them over by December.

One can possibly play with the futures to express my view, but since the December hike probabilities are not placed that high, I see little edge there either.

So I falling back on my core strategy that I have expressed in my book “The Next Perfect Trade: A Magic Sword of Necessity” (now out on Amazon: ://tinyurl.com/q3sdqpo ):

I will see the forest behind the trees and I will not be afraid to enter.

I try to ignore the short-term volatility and stick to strategies which are not dependant on the exact Fed path.

There are two broad possibilities:

1. Fed never hikes and possibly goes to QE4. In this case being long UST’s will be earning excellent carry forever.
2. At some point the Fed hikes which is likely to cause curve flattening and stronger dollar, whenever that happens.

Long dollar and long bonds was the perfect trade of 2014. The two components were very nicely negatively correlated and were both grinding up overall, delivering an insane Sharpe Ratio (for those who care about Sharpe).

The correlation party is over in 2015. This year is a lot about positioning, so be prepared for every kind of counter-intuitive outcome.

Buy the rumor, sell the fact, and then buy the fact to fade the selling of the fact.

Don’t necessarily expect bonds (with the exception of the very short end) and equities to go up on the “hold” and “down” on the hike.

• First, as I have pointed out many times already, at the beginning of a hiking cycle the long end interest rates have no clear correlation with the overnight policy. 
• Second, the idea of “dovish hike” or “hawkish hold” muddies up the issue quite a bit.

And positioning is what is likely to matter. If you do care to trade over the meeting – watch what will overextend before the FOMC meeting – it will be more likely go the opposite way afterwards, regardless of the outcome.

I have to be patient and cautious. While my strategic imperative is to still to be long both dollar and bonds, both positions may be hurt by a “hawkish hold”. Or not. Bonds are being beaten down into the Fed, which make me more bullish.

So my inclination with respect to predicting the FOMC is DON’T BOTHER. There will be better trading spots

Image: la libertad tiene un precio by marta … maduixaaaa