The Consensus Still Points to a Rate Hike in December

Friday’s Bureau of Economic Analysis (BEA) October Personal Income and Outlays report was most important to the Fed.

The Fed has been talking about a rate hike in December for a long time. They say the decision is based on improving data. They’re especially focused on wages and prices (inflation), but they are also worried about creating a market melt-down (which is probably why they haven’t already hiked rates).

The good news was that personal income was up in October, as expected – a healthy 0.4%.

The bad news was that spending was lower than expected and doesn’t bode well for the holiday season. That figure confirmed the poor retail sales figures from a couple weeks ago.

Worse yet, the Fed’s favorite inflation indicator, the PCE price index, also disappointed. The headline number was up only 0.1% with expectation at 0.3%. The core number, which excludes food and energy, was unchanged while it was expected to be up 0.2%. The Fed is looking for an annual inflation rate approaching 2%, but it’s coming in at just 1.3%!

So what was the reaction in the markets to Friday’s data? Nonexistent. That day the bond market barely moved and now sits right at 3%.

Still, U.S. Treasury bond yields have been falling steadily for the last two weeks.

When yields spiked last month on a strong jobs report, the odds of a rate hike moved from about 50% to over 80%. Now, that likelihood has fallen back to about 65%. But the overall consensus is that the Fed will most likely hike.

Still, the market isn’t so concerned about the first rate hike, but what comes later. Bond yields have already priced in a December hike, so when it happens traders will be focusing on future action. And right now, because of weak inflation and wage growth, a future rate hike isn’t a big worry.

Again, we don’t care what the Fed does! We’re looking for an overreaction in the long-term bond market. Surprises create these overreactions, and there are always opportunities for surprise.