23 Mar 2015
Are Fed hikes this year really a certainty? – BAML
FXStreet (Barcelona) - Strategists at BofA-Merrill Lynch, explains that if inflation and its core components continue to decline, the Fed might delay its hikes, and further suggest an options strategy to position for a further decline in inflation.
Key Quotes
“The FOMC dot plot released last week showed the apparent convergence of participants’ views on the medium-term rates outlook. All but two participants project Fed hikes by the year-end, with a large cluster (41%) projecting exactly two hikes.”
“On the surface, this seems to indicate the Fed is almost certain to start normalizing rates this year. And the rates market seems to think so. The implied probability of a no hike outcome is only 14%.”
“…we believe the market underestimates the likelihood of such a scenario. If inflation, especially its core components, continues to decline, it would be very difficult for the Fed to be “reasonably confident” that inflation is on track to move back to the target over a medium-term horizon, in our view. As a result, we think the Fed may delay hikes if core inflation continues to decline this year.”
“The bottom line is inflation is inherently poorly predictable, so it is hard to be confident about near-term direction of inflation, even with the tighter labor market. As a result, we see substantial likelihood, perhaps not very far from 50%, that core inflation may end up lower by year-end. As discussed, the policy statement’s language strongly suggests the Fed may find it difficult to hike in that scenario.”
“We suggest positioning for a further inflation decline by buying 1x2 call spreads on December Eurodollar futures financed with OTM puts. Specifically, we recommend buying 1x2 EDZ5 99.375/99.625 call spreads vs selling EDZ5 98.875 puts.”
Key Quotes
“The FOMC dot plot released last week showed the apparent convergence of participants’ views on the medium-term rates outlook. All but two participants project Fed hikes by the year-end, with a large cluster (41%) projecting exactly two hikes.”
“On the surface, this seems to indicate the Fed is almost certain to start normalizing rates this year. And the rates market seems to think so. The implied probability of a no hike outcome is only 14%.”
“…we believe the market underestimates the likelihood of such a scenario. If inflation, especially its core components, continues to decline, it would be very difficult for the Fed to be “reasonably confident” that inflation is on track to move back to the target over a medium-term horizon, in our view. As a result, we think the Fed may delay hikes if core inflation continues to decline this year.”
“The bottom line is inflation is inherently poorly predictable, so it is hard to be confident about near-term direction of inflation, even with the tighter labor market. As a result, we see substantial likelihood, perhaps not very far from 50%, that core inflation may end up lower by year-end. As discussed, the policy statement’s language strongly suggests the Fed may find it difficult to hike in that scenario.”
“We suggest positioning for a further inflation decline by buying 1x2 call spreads on December Eurodollar futures financed with OTM puts. Specifically, we recommend buying 1x2 EDZ5 99.375/99.625 call spreads vs selling EDZ5 98.875 puts.”