MBS Day Ahead: Is The Market Too Far Ahead of a Predictable Fed?

Today is Fed day and naturally, that's where 100% of the focus has been and will be.  Markets are convinced that the Fed will remove the word "patient" from the statement and that the removal is meaningful.  Funny thing about markets though... in this case, they've already "written" that part of the FOMC statement.  It's so widely-accepted that "patient" is going away that the biggest surprise would see it remain.  It would also reflect very poorly on the Fed to be given such an open door (via the widespread consensus) to begin evolving their verbiage toward the removal of accommodation, and to do nothing with it.

More importantly, does "patient" even matter in the first place? 

No, no it doesn't.  It never did, and neither did the good old "considerable time" verbiage that filled the role "patient" is filling now. 

Why all this cynicism?

Because Fed statements are boring now!  It used to be that we had real substance (despite inflated word counts), referencing quantitative easing purchases, actual calendar dates for future policy expectations, and actual numerical targets for certain growth metrics such as the unemployment rate.  Gone are the days where we could look forward to hunting out this particular phrase to make sure the date hadn't changed: "likely to warrant exceptionally low levels for the federal funds rate at least through late 2014" or "at least through mid-2015"

"Patient" only became important because "considerable time" went away, which only became important because the unemployment target went away (embarrassingly), which only became important because the 2015 verbiage went away, which only became important because the 2014 verbiage went away.

Markets are clinging to the past in the hopes of squeezing some bloody significance out of a very boring old rock.  But that doesn't mean the statement, as a whole, isn't interesting or important!  the point is that won't be determined by the presence of "patient."  Patient is already gone (and if it's not, the Fed loses credibility)

The Fed obviously doesn't want to lose credibility.  Otherwise, there's really no great way to justify the push toward a mid-2015 rate hike.  After all, they did say "at least through mid-2015" way back in late 2012.  Wouldn't they look clever if they hiked in June!

Seriously though, that wouldn't be clever from a practical standpoint.  Yellen herself (who incidentally also has the best forecasting record among her peers) just a few weeks ago said she expects inflation to go lower before it goes higher.  While it's true we do have some Fed members giving talks in favor of earlier hiking, several of them are non-voters or soon-to-be retired.

Let's not forget the Minutes from the last Fed meeting were clear in laying out the collective stance: "many participants observed that a premature increase in rates might damp the apparent solid recovery in real activity and labor market conditions, undermining progress toward the Committee's objectives of maximum employment and 2 percent inflation. In addition, an earlier tightening would increase the likelihood that the Committee might be forced by adverse economic outcomes to return the federal funds rate to its effective lower bound."

When we read those minutes, markets were sure the first rate hike would be September or later.  Two strong employment reports later, and this magically means the rate hike is moved up to June?!  Given the fact that the Fed has absolutely no recent history of changing it's general policy stance based on 2 months of employment data, don't be surprised if the Fed doesn't see things quite so simply today.  The less they echo market anxiety regarding strong data's implications, the better it will be for us.

The wild card is the European situation.  We know there had been some concern about this.  The Fed actually mentioned it in several venues, of course.  But I think the Fed would hesitate to put too much official emphasis on overseas economics.  In other words, the European situation is something of a silent partner.  Now that there's some semblance of traction in European economic data and given that QE carried rates well into all-time lows, that silent partner might vote in favor of a more hawkish Fed. That would be bad for rates, but again, we won't really be able to confirm this unless they drop a hint in the statement or if Yellen does in the press conference.