What’s brewing in the market? According to the CME Fed Watch tool, the excitement is sky-high as it’s shouting out a whopping 99.8% probability of a 25bps rate hike in the upcoming FOMC meeting on July 26th! But the critical question is, what is next? Are we done? A rundown of our thoughts below.

What does the rates’ market price?

According to the CME Fed Watch tool the market is currently pricing a whopping 99.8% probability of a 25bps on the next FOMC meeting on the 26th of July. For the market, another hike is done a dusted!

So far, all clear, but what’s next? The market is telling us that we are probably pretty much done after that, (see chart below)

as the market then prices an 83% probability of the FED being on hold in September

The probability of another residual 25bps hike in November is relatively slim: less than 30%!

Unveiling the Atlanta Fed’s Taylor Rule Model: A Comprehensive Overview.

Discover the Federal Reserve of Atlanta’s in-depth analysis of the Taylor rule on this informative link. The Atlanta Fed’s website offers a valuable array of resources, providing valuable insights into modelling the Taylor rule and exploring relevant modifications. Let’s delve into the world of monetary policy and gain a clearer understanding of how the Federal Reserve employs the Taylor rule as a critical tool in shaping economic decisions. The burning question remains: Have we reached the peak rate according to the Taylor rule?

Our modified Taylor rule shows the following:

We decided to use the Taylor 93GDP model, keeping the inflation target at 2%. To calculate the output gap, we derived it from the Congressional Budget Office’s (CBO) estimate of potential real gross domestic product. For the interest rate smoothing coefficient, we went with “0”, while setting the resource gap weight at 0.5.

Now, here’s where our model takes a twist! Our inflation measure isn’t your typical run-of-the-mill approach found on the Atlanta FED website. Instead, we defined it as the average between the latest core PCE inflation number (currently at 4.6%) and the Q4 2023 core PCE according to the latest survey of professional forecasters from the Federal Reserve Bank of Philadelphia (clocking in at 2.9%). That’s where we stand out from the crowd! 😎

The reason we employ the latest core PCE (Personal Consumption Expenditures) data and a professional forecast is that we believe the Federal Reserve blends current hard data with forward-looking measures to make more informed decisions. By combining the most recent actual data on core PCE inflation with the forecast from professional economists, we aim to capture both the present economic conditions and the short-term outlook.

Conclusions

Based on the Taylor rule and our modified model, it appears that we are not too far off the mark. According to our calculations, the current Fed Fund rate should ideally be around 5.5%. Interestingly, this aligns closely, if not precisely, with what the market is already pricing in for the rate after the next FOMC meeting.

However, the real litmus test lies in the upcoming press conference on Wednesday. While we don’t expect any major announcements, it’s crucial to keep in mind that the Fed won’t commit to a defined path just yet. The terminal rate remains highly dependent on economic data, especially the next few inflation prints, which will play a pivotal role in shaping future decisions. Those who anticipate the Fed to announce being on hold may be disappointed as this cautious approach is likely to prevail. The Fed’s stance will likely remain data-dependent, and they will carefully gauge economic indicators before making any significant moves.

As we move forward, this element of uncertainty may keep the market on its toes, leading to potentially increased volatility in anticipation of the next set of economic data points. While the Fed’s insights might offer some guidance to investors, all eyes will soon turn to a highly anticipated earning season, which promises to be action-packed and could become the primary driver of market movements in the weeks ahead.

Stay informed and stay tuned for Giorgio’s comments! We’ll keep you updated on our views and analysis of the ongoing earning season, which is now in full swing. Our insights will help you navigate these dynamic markets and make well-informed decisions. So, let’s gear up and get ready for the excitement that lies ahead!

Happy trading!

InflectionPoint Team

Disclaimer

All views expressed on this site are my own and do not represent the opinions of any entity with which I have been, am now, or will be affiliated. I assume no responsibility for any errors or omissions in the content of this site and there is no guarantee for completeness or accuracy. The content is food for thought and it is not meant to be a solicitation to trade or invest. Readers should perform their investment analysis and research and/or seek the advice of a licensed professional with direct knowledge of the reader’s specific risk profile characteristics.