As per the expectation, the November FOMC meeting went uneventful. The Fed seemed to have two major objectives: to hold onto prospects of December rate hike while also maintaining flexibility to delay action, should events in the next two months not materialize as expected. The statement suggests that the Fed achieved these goals and we continue to expect a rate hike at the December meeting. 

Regarding the statement, the committee downgraded the pace of household spending to “rising moderately” from “growing strongly.” This is not a surprise given the release of the advance estimate of Q3 GDP, which showed private consumption rising 2.1% QoQ SAAR on the quarter versus 4.3% in Q2. In a surprise to us, the committee upgraded its assessment of inflation in three different places.

First, it said that “inflation has increased somewhat since earlier this year” versus “continued to run below the committee’s 2 pct longer-run objective.”

Second, the statement now says market-based measures of inflation compensation “have moved up a bit” as opposed to simply remaining low.

Third, the committee took out the reference to inflation remaining low in the near term, “in part because of earlier declines in energy prices.” The expectation seems that these items to come out at the December meeting, when the projection on a decision to raise rates would be taken, but the committee clearly chose to signal its view about the likelihood for action at its next meeting by upgrading its assessment of progress on inflation. 

Given that markets are already pricing in a significant probability of action at the December meeting, we did not expect the committee to use the “at its next meeting” language as it did last year when it felt that market pricing was out of line with its anticipated actions. Consequently, the statement added that the case for a rate hike “continued to strengthen.”

We believe that a combination of incoming data on labor markets and inflation, along with building concerns within the committee about medium-term risks to financial stability, will tip the balance in favor of a rate hike at the December meeting.

Should the Fed fail to raise rates after signaling repeatedly for a rate hike this year, the FOMC would be likely to experience a further loss in credibility. In addition to election-related outcomes that could result in an unwanted tightening of financial conditions, considerable risk is that further rise in the participation rate in Friday’s October employment report.

November FOMC meeting: Upgrade of inflation signals December action

OTC Updates: Please be noted that the mounting hedging sentiments for bearish risks of USDJPY across different tenors.

The implied volatility of USDJPY ATM contracts are gaining traction across all tenors even after Fed and BoJ’s monetary policies, spiking above 12% in 1-3m tenors. This volatility observation is absolutely suitable for tenor selection in diagonal put ratio back spread.

As you can see delta risk reversals are indicative of participants in this pair are more concerned about further slumps especially in next 2 month’s timeframe. Rising negative flashes indicate active hedging sentiments for these downside risks.

Acknowledge the gaining traction in the hedging sentiments of USD with higher negative risk reversals of dollar versus euro, yen, Swiss franc, while upside risks in dollar against sterling, Aussie dollar and Canadian dollar in long run is justifiable when you have to anticipate forwards rates and observe the spot curve of this pair (see IVs, RR nutshell, Sensitivities, and compare with spot prices).