Traders Face New Landscape With Powell at Microphone After Every Fed Meeting
(Bloomberg) -- U.S. rates traders are gearing up for a new landscape in 2019, when Federal Reserve Chairman Jerome Powell plans to start holding press conferences after all eight of the central bank’s meetings.
Some shift in hedging activity in the options market is expected. Traders will have to prepare for the increased risk of a policy change at the four gatherings where the Fed chief previously didn’t take questions -- or at least for potentially market-moving comments.
But strategists expect the ripple effect to be minimal and overshadowed by traders’ gaming the end of the tightening cycle amid the recent drop in risk assets that’s helped spur criticism of the Fed by U.S. President Donald Trump.
Expanding press conferences beyond just the four Fed meetings that have included updated economic and rate forecasts makes every meeting “live,” because all will present “opportunities for messaging,” said John Briggs, head of rates strategy for the Americas at NatWest Markets. “The primary influence will be to increase optionality in pricing in the very short end” of the curve, he said.
That means fed funds futures and overnight indexed swaps contracts corresponding to the other four dates, which in the past typically indicated zero chance of a rate move, may create some more business for market-makers. Eurodollar options would also be affected, and changes “will show up in higher implied vol embedded in swaption pricing,” TD Securities strategist Priya Misra said.
But there are important caveats, Briggs and other analysts say.
For one thing, each of the Fed’s nine rate increases since December 2015, including the latest on Dec. 19, have occurred at one of the quarterly meetings -- in March, June, September and December -- when officials update their Summary of Economic Projections. Strategists are skeptical about whether that approach will change. The Federal Open Market Committee’s next meeting will take place on Jan. 29-30.
Regular briefings “will incrementally increase volatility on what used to be non-press conference meetings,” said Jon Hill, a strategist at BMO Capital Markets. However, the Fed hasn’t clearly signaled an intention to use those meetings to make rate changes, so the quarterly dates “will still correspond to the most volatility in financial markets,” he said.
One way to signal such a shift would be to forgo a rate increase in March, according to Credit Suisse strategist Jon Cohn.
That “could help push the market toward legitimately pricing hikes for non-SEP meetings instead of merely a basis point or two,” he said.
The Fed took a step in that direction last week, scaling back the median number of rate increases officials expect next year to two from three and saying that “global economic and financial developments” will influence its course.
Were the market to seriously entertain the possibility of a hike between March and June, the April and May fed funds futures spread, still minimal, should widen, BMO’s Hill said.
Speculation the Fed is nearing the end of its hiking cycle also limits the impact of Powell’s increased visibility, said Jay Barry, a U.S. fixed-income strategist at JPMorgan Chase & Co.
Following last week’s FOMC meeting, JPMorgan changed its 2019 Fed forecast to three rate increases from four, but the market-implied forecast has dwindled to less than one.
“We would need to see a steeper OIS curve for markets to place more weight or put in play” the interim meetings, Barry said.
Here’s what strategists had to say about potential changes in the rates market resulting from the increased frequency of press conferences:
Jon Hill, BMO
- “We interpret the move to press conferences as a communication device rather than a signal that the Committee is suddenly going to start hiking at these meetings”
- “As a result, the same fed funds futures and eurodollar futures contracts as previously would absorb the brunt of repricing, albeit at different volume quantities/timings from before”
Tom Simons, Jefferies
- “There could be a little bit more volatility in fed funds future contracts for the ‘off-months’ relative to prior years now that they have press conferences. However, we think that factor will be overwhelmed by scrutiny over the incoming inflation data in 2019”
Jay Barry, JPMorgan
- “In the swaptions market, there tends to be a premium for options that span FOMC days, but the difference between those that include press conferences versus non-press conference meetings is not that large”
- “We think the Fed will be biased to raise rates at meetings where it releases projections in addition to having a press conference. To the extent that there is little difference in implied vol in SEP versus non-SEP meeting dates, we do not think this will have a material impact on that market”
John Briggs, NatWest
- While the Fed is likely to stick with quarterly hikes at least until June, “the very presence of press conferences should increase the potential for volatility as it increases the number of opportunities for messaging”
- This may lead to “some additional option trading and trading in front-end products”
Priya Misra, TD
- Expect “more volatility in general, but also more market volatility around non-SEP Fed meetings,” because investors will no longer have to wait three weeks for the minutes to learn more about what was discussed
- This “will show up in higher implied vol embedded in swaption pricing”
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