Will They Or Won’t They – Is A Fed Faux Pas Imminent?

Authored by Steven Vannelli via Knowledge Leaders Capital blog,

The Federal Reserve has all but cemented expectations for a 25bps rate hike next week. But, events have changed a lot in the last couple weeks that raise a faint hint that the Fed may not hike, despite elevated, persistent inflation.

What makes us question whether the Fed achieves lift-off next week? Three things: 1) deterioration of growth expectations for 2022, 2) the VIX, and 3) fed funds futures.

Since the peak in September of 2021, expectations for real GDP growth for 2022 has been steadily getting marked down. This helps explain the slide in the average stock this year—as measured by the Valueline equal weighted index. Does the Fed tighten into slowing growth?

Next, the Fed has never begun a rate hiking cycle when the CBOE VIX was this elevated. As the chart below shows, there have been three tightening cycles since the VIX began trading in 1990. In the first, which began February 4, 1994, the VIX was 15.25. In the second, which began June 30, 2004, the VIX was 14.34. Lastly, in the tightening cycle that began December 16, 2015, the VIX was just under 17.86. So, it would seem that either the Fed tightens into a VIX that is about twice the average of historic hiking campaigns, or the stock market has a pretty strong rally, bringing the VIX back down.

Likely due to the recent events in Ukraine, the market is actually not even 100% pricing in a 25bps hike next week. In all fairness, it is close at 98%, but still…

Even if they go ahead and lift off, longer term fed funds futures are not pricing in a prolonged hiking cycle. Over the last three weeks, December 2024 fed funds futures have inverted relative to December 2023.

So, will they or won’t they raise rates next week? They probably will, but the market seems to be suggesting the Fed is doubling down and possibly making another policy mistake.

Read further at ZeroHedge

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