US: Better than expected data encouraged a reassessment of the trajectory of Fed policy - BBH

Research Team at BBH, notes that the weighted average of the Fed funds rate has edged higher.  

Key Quotes

“Following the Fed hike in December 2015, the Fed funds average around 36 bp in January before moving into a 37-38 bp range.  However, since the UK referendum it has been trading consistently around 40 bp.  

The Fed fund futures contract settles at the average effective Fed funds rate for a given month, not at the policy rate.   Ahead of next week's FOMC meeting where practically no one expects a change in policy, implied yield of the July Fed funds futures contract is 40.25 bp.  

Some dealers think that one of the factors that are keeping Fed funds firm is the preparation of changes to the US money markets as of the middle of October. 

In addition to a floating NAV, prime funds will be able to impose liquidity fees and redemption gates if the funds liquidity fell below 30%. Besides these prime funds will be money market funds that invest only in government paper. 

On the surface, it appears that there has been a huge liquidation of prime fund assets and a move into government money markets. Prime funds have been preparing for withdrawals so as not to trigger the liquidity rules or the redemption gates. 

A consequence of a higher effective Fed funds rate is that it decreases the implied chance of a rate hike in the Feds funds futures market.  

The November 2 meeting is too close to the election to be live.  The December meeting is possible, like last year.  The December meeting is on the 14th.  A rate hike then would make fair value for the December contract near 52 bp yield.  It is currently implying 48 bp yields or about a two-thirds chance of a hike then. 

The string of better than expected US data encouraged a reassessment of the trajectory of Fed policy, though we will feel more comfortable when the Fed's leadership provides updated guidance, post-Brexit.  At the same time, expectations for easier BOJ, BOE, RBA, and RBNZ policy over the next several weeks have increased, and nothing Draghi said today closes the door on new initiatives as early as September.”