The Morning Call

We do not expect the FOMC meeting minutes, released on Wednesday 18 November, to meaningfully alter the already-high market expectation of a December rate hike. We think the minutes will mostly echo recent Fed signals, rather than add new colour. The last statement was surprisingly explicit, and already highlighted the possibility of a move “at the next meeting”; meanwhile, there has been unusual unity from recent Fed speeches that conditions for a rate hike are, or are about to be, met. Chair Yellen underlined at her most recent congressional testimony that hiking rates would be a “prudent thing to do”, hinting the move would come at the next meeting.

The minutes may look stale as the Fed did not have on hand the latest employment report, which showed a surprising jump in job growth, a lower unemployment rate, and signs of accelerating wage growth. This report likely cemented further the belief among Fed members that a December move is appropriate. The Fed is mostly basing its first hike on the expectation of higher future inflation, rather than actual inflation (which likely remains low as Tuesday’s CPI data could show once again) as the labour market continues to tighten.

Of interest in the minutes will be what risks could derail a December hike. An obvious one would be a sudden deterioration in market sentiment. We think it would be difficult for the Fed to go ahead if the Chicago SPX Volatility Index (VIX) rose above 30. We do not think the minutes will be this explicit, but the Fed may hint at the need to see conducive market developments. New York Fed President Dudley reiterated the importance of broad financial conditions as the Fed prepares to tighten. Recent minutes showed significant discussion of USD appreciation, and it will be interesting to see whether this continued at October’s meeting. The Fed may emphasise very gradual policy rate tightening after the initial hike. The minutes may also give further details on the use of the reverse repo facility once tightening begins.

For USD rates, curve flattening has re-emerged in recent days following the bear steepening move in the wake of the latest strong payroll report. In the process, market expectations of a December hike have retreated marginally. We therefore expect the minutes to push up short-end rates, but the market may now view the hawkish tone in the context of renewed equity fragility last week and recent sub-consensus data such as retail sales, producer prices and the Empire survey. Hence, we expect the minutes to support the resumption of the USD curve’s flattening bias.