The Fed’s “mouthpiece” says this time it will not only raise rates, but there will be another hike before the end of the year. Its accuracy is almost 100%, and this is consistent with current market expectations.
Rate hikes are basically a done deal. In the past few years, there has never been a case where anyone predicted the Fed would raise or cut rates with a 90% probability, and then turned out to be wrong—because that would severely undermine the Fed’s credibility. There’s no need to doubt a hike. If at this point anyone tells you, with chest-thumping confidence, that there will absolutely be no rate hike, treat them as a lunatic.
In terms of stock options, market pricing for this time is expected to be about ±1% S&P 500 movement on the day. The market acknowledges a normal-sized bout of volatility from a standard Fed announcement, but it is not buying protection against a “big crash” scenario triggered by the rate hike shock + the oil price shock.
Has the market priced it in sufficiently?
1) A 25bp hike is basically already fully priced. The marginal impact of the actual hike on stocks and bonds is typically smaller than the impact coming from the statement, the dot plot, and the press conference. In normal markets, the volatility realized over the prior few days is what comes from the repricing, not on the day of the Fed’s event.
2) The dot plot and the subsequent path have not been fully priced. If the dot plot is revised upward, that would mean resetting to even worse expectations for U.S. equities, with inflation concerns once again made the primary focus.
3) Pricing in the options and futures markets only accounts for volatility consistent with expectations; it does not price in extreme scenarios. If you get a combination of a rate hike + a more hawkish dot plot + yields breaking down, the realized volatility would be clearly higher than the current ±1%.
The conclusion is that, based on current market pricing, the market has essentially already bought the 25bp hike on Wednesday with high probability, implying roughly ±1% decision-day volatility for the stock market. But it has not bought enough to fully account for a longer, higher-rate path, or for the sustained upward drift in volatility after the meeting. The fate of the market is entirely in the hands of the dot plot and the Fed official’s remarks.
Rate hikes are basically a done deal. In the past few years, there has never been a case where anyone predicted the Fed would raise or cut rates with a 90% probability, and then turned out to be wrong—because that would severely undermine the Fed’s credibility. There’s no need to doubt a hike. If at this point anyone tells you, with chest-thumping confidence, that there will absolutely be no rate hike, treat them as a lunatic.
In terms of stock options, market pricing for this time is expected to be about ±1% S&P 500 movement on the day. The market acknowledges a normal-sized bout of volatility from a standard Fed announcement, but it is not buying protection against a “big crash” scenario triggered by the rate hike shock + the oil price shock.
Has the market priced it in sufficiently?
1) A 25bp hike is basically already fully priced. The marginal impact of the actual hike on stocks and bonds is typically smaller than the impact coming from the statement, the dot plot, and the press conference. In normal markets, the volatility realized over the prior few days is what comes from the repricing, not on the day of the Fed’s event.
2) The dot plot and the subsequent path have not been fully priced. If the dot plot is revised upward, that would mean resetting to even worse expectations for U.S. equities, with inflation concerns once again made the primary focus.
3) Pricing in the options and futures markets only accounts for volatility consistent with expectations; it does not price in extreme scenarios. If you get a combination of a rate hike + a more hawkish dot plot + yields breaking down, the realized volatility would be clearly higher than the current ±1%.
The conclusion is that, based on current market pricing, the market has essentially already bought the 25bp hike on Wednesday with high probability, implying roughly ±1% decision-day volatility for the stock market. But it has not bought enough to fully account for a longer, higher-rate path, or for the sustained upward drift in volatility after the meeting. The fate of the market is entirely in the hands of the dot plot and the Fed official’s remarks.