TD Securities’ Molly Brooks has highlighted significant mispricing in US rates markets ahead of the September Federal Reserve meeting, with unusually high uncertainty surrounding whether the Fed will hold rates or implement a 25 basis point hike. Brooks notes that market pricing going into the Fed's blackout period shows historically large deviations compared to past outcomes, with Friday’s August CPI report expected to drive a substantial repricing in rates and determine investor strategies regarding the meeting outcome [1].
According to Brooks, the market is currently the most mispriced for both a hold and a hike in the September meeting as the blackout period begins. Historically, repricings during blackout weeks are limited, but the upcoming CPI release is likely to move markets, presenting opportunities for investors to either fade current pricing or pay for a hike depending on their inflation outlook [1].
Brooks provides concrete data: in meetings where the Fed holds rates, the highest under- and overshooting of pricing is around 7 basis points, while for a 25bp hike, the range is +/-9bp. However, Friday's pricing would result in a 15bp deviation for a hold and a 10bp deviation for a hike, marking the highest uncertainty in both scenarios. She also notes that in every previous scenario where markets priced at least 16bp going into the blackout period, the Fed hiked, with the largest underpricing occurring in December 2018 when the Fed's move was viewed as a dovish hike [1].
Brooks concludes that if the Fed does hike, this is likely the lowest cost of paying for the meeting, as pricing remains near its highest since July. However, TD Securities does not expect the inflation data to support a Fed hike, suggesting that this would be the largest opportunity to fade market pricing if the Fed holds rates [1].
CONCLUSION
TD Securities identifies unprecedented uncertainty and mispricing in US rates markets ahead of the September Fed meeting, with the August CPI report expected to be a decisive factor. While market pricing suggests a high likelihood of volatility, TD Securities anticipates inflation data will not support a hike, presenting an opportunity for investors to fade current pricing if the Fed holds.