Dot Plot Fever! Fed’s Dot Plot Detached From Market Pricing (Target Rate CUT More Likely Than Rate Increase)

The Federal Reserve may be suffering from “Dot Plot Fever.” 

The Fed may need to lower the expected path of rate hikes (the “dot plot”) to satisfy equity markets, which appear to be pricing for less-hawkish monetary policy in the coming year. The S&P 500’s current multiple of about 18.5x trailing EPS implies slightly less than one 25-bp hike through the next 12 months, based on our fair-value model. Bond markets, measured by OIS and fed funds futures prices, appear to be expecting no change in the latter over that time.

If the Fed reduces expectations in-line with bond markets, equity markets would likely get a significant boost. Our fair-value model suggests the current level of two-year yield and yield-curve spread imply a market multiple closer to 20x.

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The financial market isn’t expecting any target rate increases, but a rate cut is in play for Q4 2019 and Q1 2020.

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Inflation, as measured by the US Federal Government, is rising and at its highest level in several years. But the 2-year Treasury Note yield continues to slide.

realea

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