Fed Funds Take Baby Steps Toward Dot Plot

Mr. Market seems to hate taking the Federal Reserve at their word, setting up an epic game of chicken for financial markets.

For most of the year, despite ad infinitum assurances from Federal Reserve big shots that they had no plans to cut rates, Fed Funds futures were predicting between one and three cuts by year end.  In recent weeks, futures traders finally disavowed themselves of that notion.  Then, after the “dot plot” from the most recent FOMC meeting showed a only median expectation of 5.625% (3/8% above the current 5.25% top end of the target range), futures were pricing in one more rate cut this year – maybe.  Today, after a strong run of economic data, we see Fed Funds futures finally figuring in tiny odds for a second hike this year. 

To be fair, the expectation remains quite modest.  Bearing in mind that the midpoint of the current target is 5.125%, we currently see November Fed Funds trading at 5.36%. That means that futures are pricing in a 10% chance for a second quarter-point hike.  The bump is thanks to some hotter-than-expected economic data released today. 

Durable Goods came in at +1.7%, well above the -0.9% consensus estimate.  All the various sub-measures for Durable Goods – Ex Transportation, Nondefense Ex Air, etc. – all came in higher than expected as well, though by smaller magnitudes. 

Housing was another source of strength.  The FHFA House Price Index rose by 0.7% versus the 0.5% consensus.  S&P Corelogic month-over-month gained 0.91%, vs. 0.4% consensus.  New Home Sales spiked to 763,000, well above the 675,000 expectation.  That caused the monthly percentage gain to be an eye-popping +12.2% instead of -1.2%.

Consumer Confidence, as measured by the Conference Board, popped to 109.7, well above the prior 102.5 (revised up from 102.3) and the 104.0 consensus.  Expectations and the Present Situation measures both rose as well.

Taking all these reports as a whole, is there any reason to doubt the Fed’s intentions?  Housing is one of the most interest-rate sensitive sectors there is, yet higher rates are not appearing to diminish neither demand nor prices.  The rise in new home sales could plausibly be a function of rate hikes; it is said that homeowners with, say, 3% mortgages are reluctant to move when another home will require a mortgage at nearly double that rate.  That could indeed push new buyers into new homes rather than existing ones.  The recent rally in homebuilder stocks is somewhat predicated on that logic.  But if house prices are rising across the board, that is a negative for an inflation-fighting Fed, since those push up the owner’s equivalent rent calculation that is inherent in inflation measures.

And if both businesses and consumers are sanguine – as measured by the Durable Goods and Consumer Confidence reports, that is another sign that the recent rate hikes are not unduly affecting either group.  So, if businesses are buying goods that generally require financing, consumers are paying up for homes that also require financing, and at the same time consumers feel good about their economic situation, it stands to reason that the Fed has more room to raise rates.

We were resolute in stating that a rate cut was not on the horizon unless a recession or financial accident spurred the Fed into one.  In other words, be careful what you wished for.  The same idea may be the case now, but for the opposite reason.  Outside of the most degenerate liquidity junkies, no one really wants a recession.  As one appears to be less likely – at least in the short-term – a stronger economy raises the chance that the Fed will continue to hike further.  Maybe at some point we should start listening to them, no?