Federal Reserve: Market mispricing risk into blackout – TD Securities

TD Securities’ Molly Brooks analyzes how US rates markets are pricing the September Federal Reserve meeting, highlighting unusually high uncertainty around a potential hold or 25bp hike. She notes that pricing going into blackout implies historically large deviations versus past outcomes, and argues that Friday’s August CPI will likely drive a significant repricing in rates and determine whether investors should fade current pricing or pay for a hike.

Rates mispricing around September Fed decision

"Markets are the most mispriced for both a hold and a hike in the September meeting going into blackout period. While we tend to not see large repricings during blackout period weeks, CPI is likely to move markets, providing an opportunity to fade the pricing or pay the meeting depending on investors' views on the inflation print."

"Market uncertainty around the Fed's action in September remains high, with its stance hinging upon the pivotal August CPI report. While we have discussed Warsh's Fed being more likely to be mispriced the day before the meeting as forward guidance subsides, we investigate historical pricing during Fed's blackout periods."

"In meetings that the Fed holds, the highest under and over shooting of pricing is around 7bp, while for a 25bp hike, the range is +/-9bp. Friday's pricing would lead to a 15bp deviation for a hold and a 10bp deviation for a hike, signaling the highest uncertainty in both scenarios."

"In other words, in every other scenario where we priced at least 16bp going into blackout period, the Fed hiked. The largest underpricing was in Dec 2018, where the Fed hiked but markets viewed the move as a dovish hike."

"If the Fed does indeed hike, this is likely the lowest cost of paying the meeting that it will be. Pricing remains near its highest since July. Still, it is our view that we do not expect inflation data to support a Fed hike, meaning that this would also be the largest opportunity to fade market pricing in the scenario of a hold."

(This article was created with the help of an Artificial Intelligence tool and reviewed by an editor. Know more.)