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We would like to highlight that the shift in tonality seen in the FOMC minutes most probably stems directly from the Fed core (Yellen, Fischer, Dudley, Brainard) who are doves by nature.

Following this, we have already seen some dovish shifts from Fed Kaplan and Evans.

  • Kaplan said that while recent soft data was "likely transitory", he's "not certain of that" and he intends to be patient in assessing upcoming data. He also pointedly refused to answer a question on whether a Jun hike was appropriate.
  • Evans indirectly signalled a preference for a slow tightening path. He said that below target US inflation is "a serious policy outcome miss".
    • He also called out his "conservative" CB counterparts, saying that they focus too much on steepening the tightening path to compensate for projected inflationary pressures stemming from low unemployment.
    • He added that because of this, CBs pursue "overly restrictive conditions" and "deliver lower than optimal inflation".
    • He further made reference to his recent research paper that argued that the Fed doesn't have much room to cut rates before having to delve into unconventional policies such as QE/negative rates in the case of a fresh econ shock, and that this risk means the Fed should tighten extremely slowly this yr and next.

The risk we see ahead is that the other Fed officials will have to somehow align themselves with the Fed core's "prudence" caveat, which means the implied odds of a 3rd hike in 2017 could decline further ahead.

  • According to OIS markets, the probability of further tightening from Nov onwards has fallen by around 5%.

Whilst a Jun hike is still widely expected and market implied odds have actually risen post-minutes to 87.7% (CME), our models have backtested Fed communication over the past few yrs and found something rather interesting. Over the past 2yrs, a dovish shift has not been seen directly preceding the 3 previous hikes.

Not a hard and fast rule of course and there's always a first, but the question we would pose is could the market be in for a shock come Jun with the Fed staying on hold?

At this stage, this is very much the outlier risk although worth noting. JH

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