FOMC meeting to be the main event this week - BMO CM

In the week ahead, despite the market fully pricing-in a rate hike, analysts at BMO Capital Markets expect that the FOMC meeting will be the main event, followed closely by the November CPI data and Retail Sales.

Key Quotes

“The Fed is going to deliver another quarter-point of tightening on Wednesday and while that aspect of the FOMC meeting is a foregone conclusion, the open question remains how will the Committee characterize the broader economic and inflation outlook. And let us not forget the updated projections – including the dotplot. We’re not anticipating any significant changes to the Fed’s rate projections, although if anything the better core-CPI prints (i.e. not disappointing in August and October) could bias the 2018 dots a touch higher. That’s more of a risk than a call per se, as we expect Yellen will be content not to rock the boat as she drops the mic on the way to her first-quarter speaking tour.” 

“As for the economic data, the inflation reports will be the most relevant and with core-CPI seen increasing +0.2% in November, the yearly pace is expected to remain steady at 1.8%. We’re viewing this week as an important test of the notion that even the return of moderate inflation won’t materially challenge the flattening bias. As a point of clarity, an as-expected or higher core-inflation print will be met by an initial steepening of the curve – that much is intuitive. What remains to be seen is if that marks the beginning of a broader reversal of the recent flattening trend. This is of particular interest to us because our yield forecast for next year is based on the assumption that the market is entering a traditional mid-cycle trading pattern in response to increases in yearover-year inflation gains.” 

“The essence of the question comes down to whether or not more realized inflation is viewed as enhancing the Fed’s credibility (i.e. Yellen was right to get in front of the data). In prior mid-tightening cycles, that has led to underperformance of the front-end of the curve and exacerbated any flattening trend that was already established.  This differs from the curve’s response when the Fed is actively easing or policy is on-hold, hence why we’ll be so eager to see how the market reacts to a solid core-inflation print and a Fed hike on the same day. We’re clearly biased to see the 2- to 5-year sector selloff more quickly than 10s and 30s, but we’re cognizant that there are many leaning the other direction on this as evidenced by the significant short-base in the ultra-long futures contract.”