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Four or Five Rate Hikes in 2016? Really?

I am quite amused by the parade of Fed governors and presidents still toting the Yellen line that the Fed will hike three to five times in 2016, most likely four.

On January 4, MarketWatch reported Fed's Williams Foresees Up to Five Rate Hikes This Year.

The Federal Reserve could raise interest rates as many as five times this year, according to San Francisco Fed President John Williams.

"I think something in that three-to-five-rate-hike range makes sense, at least at this time," Williams said Monday in an interview on the cable news channel CNBC.

Williams said the U.S. economy is "in very good shape" and remains stronger than other major global economies.

The economy is on pace for continued job gains in 2016 after adding an estimated 2.5 million jobs last year, he said.

Williams said he was not surprised or concerned by weak Chinese economic data, which many blame for Monday's stock-market selloff. China, he said, has been undergoing a pretty significant shift for some time away from manufacturing and toward consumer spending.

Williams said he doesn't have a stock-market terminal on his desk telling him when the market moves up and down. He said the Fed is focused on the medium term and understanding why the market is moving, "rather than responding to just ups and downs."


Fed Frontloaded Massive Market Rally

If Williams wants to know why the market is as high as it is, he would gather the Fed members together and instruct them to look in a mirror.

In an act of contrition, Former Dallas Fed president Richard Fisher went to the Squawk Box confessional admitting: "We Frontloaded a Tremendous Market Rally."

Fisher, no longer a Fed president, is now free to squawk.

If you have not yet done so, please click on that link for a transcript of the video. It's a real eye opener.


Fed Fund Futures Don't Even Believe in Four Hikes

On January 4th, the day Williams was parroting Yellen, I captured a snapshot of Fed Fund Futures and plotted them in Excel.

Implied Interest Rate

That chart reflects the single most likely interest rate following each Fed meeting. Here is the probability table.


Implied Rate Hike Probabilities on January 4

FOMC Decision Date Single Most Likely Interest Rate Weighted Interest Rate Implied Probability Odds Higher Odds Lower Odds of 0% Rate
1/27/2016 0.50% 0.50% 90.50% 9.50% 0.00% 0.00%
3/16/2016 0.75% 0.75% 50.30% 4.80% 44.90% 0.00%
4/27/2016 0.75% 0.75% 49.90% 13.00% 37.60% 0.00%
6/15/2016 0.75% 1.00% 45.00% 31.40% 23.50% 0.00%
7/27/2016 0.75% 1.00% 40.90% 40.10% 19.00% 0.00%
9/21/2016 1.00% 1.00% 34.40% 22.80% 42.70% 0.00%
11/2/2016 1.00% 1.25% 33.90% 29.90% 36.20% 0.00%
12/21/2016 1.00% 1.25% 32.50% 37.30% 30.30% 0.00%

The single most likely rate is not the best way to depict things. Note that in December, the single most likely rate is 1.00% but there was a 37.3% chance of something higher, but only a 30.3% chance of something lower.

Giving the rate-hikers the benefit of the doubt when close, I estimate traders expected something between two and three hikes coming.

I displayed three hikes in the following chart.


Weighted Probabilities

Weighted rate Hike Schedule


December 21 Meeting Probabilities on January 4

December 21 Meeting Probabilities on January 4

Note the skew towards an additional hike. Let's check again after the close on January 6.


December 21 Meeting Probabilities January 6

December 21 Meeting Probabilities on January 6

The market is now barely pricing in two hikes for the entire year. I will believe four when I see them.

None seems more likely to me. Economic risks are hugely to the downside, and I have not seen anything to change my mind about a pending recession. A strong jobs report on Friday won't do it. I expect massive layoffs in February.

 

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