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Fed Says “Maybe December,” Capital Flows Say “No Way”

On Wednesday, the Federal Open Market Committee (FOMC) left the Fed Funds Effective rate unchanged (the policy band is from 0–25 basis points), but noted that the next meeting on, December 16, 2015, was essentially a “live” meeting where they will consider raising rates. Additionally, unlike the previous meeting in September, the FOMC statement did not note concern over global economic and financial conditions. Fed speakers cited these global concerns as a reason for not tightening in the days following the September meeting.

The reaction to Wednesday’s FOMC statement was a swift sell off in rates with the five-year Treasury hit hardest, increasing in yield 10 basis points. Additionally, the probability of a December 2015 rate hike increased from 32% to 50% as implied from the Fed Funds Futures market. I continue to believe that the Fed missed its chance to tighten without doing much (or any?) real damage when they passed in September.


Once the European Central Bank (ECB) jumped in front of The Fed last week with a near promise to expand their $1 trillion Euro Quantitative Easing program at their December 3, 2015, meeting and the People’s Bank of China cut rates a few hours later, the Fed was, in my opinion, put in a box. The Fed raising rates, even 25 basis points as the ECB is printing a whole new fresh batch of Euros, is a recipe for Dollar/Euro parity. The dollar will rise significantly with all of our global trading partners, and that will have a negative impact on a domestic economy that is already showing signs of cooling. That isn’t a good fundamental for the financial markets the Fed is concerned with.

Moreover, the country that concerned the Fed the most in September, China, hasn’t shown any material signs of economic improvement. As China, along with Europe continues to remain idling, the demand side for commodities, especially oil, continues to be weak. When you add weak commodities and a strong U.S. dollar, you get bad news for emerging market assets and U.S. high yield bonds. If you put all this together, the only reason The Fed has for tightening in December is to avoid looking “wishy-washy.”

Additionally, in all the hoopla of Wednesday’s FOMC, there’s a sizeable minority of voting members in the FOMC who are strongly against raising rates in 2015 being overlooked. They will be hitting the seemingly endless Fed Governor talking circuit very soon and their dovish voices will be heard. A Fed this divided is very rare and they have a leader, Chairwoman Yellen, who really believes in consensus.

So, I don’t think the Fed will raise rates in December. You know who else doesn’t? The piles of cash on the sidelines that we have spoken about the last few weeks that have begun to be put to work in risk assets. On Thursday, $19.5 billion Investment Grade corporate issuance was priced and traded very well. Dealer inventories of secondary positions in that market (as well as other spread product) remained lean, new issue concessions were well-priced, and the very heavy issuance traded successfully. Additionally, as this corporate issuance was being priced, the U.S. Treasury auctioned $29 billion seven-year notes and the auction traded right on the screws. And finally, stocks have held their own with the S&P 500, up 1% post-FOMC.

As I said last week, I liked the five-year point on the Treasury curve. If I liked it at 1.34%, I love it at 1.53% (a little less than a point loss for those keeping score). To be fair to that position, besides the Fed, the five-year was effected by a $35 billion five-year auction an hour before the FOMC and then by Thursday’s heavy corporate issuance. Additionally, with our positive view on duration, we continue to like high coupon (4.5–5.5%) longer dated Tax Exempt Municipals with 7- to 10-year first call structures.


Member SIPC & FINRA. Advisory services offered throughSWBC Investment Company, a Registered Investment Advisor.

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