Warsh Tells Traders to Watch the Data. They Still Follow the Fed

(Bloomberg) -- Early on Oct. 14, just hours before the release of a much-anticipated report on US inflation, TD Securities' Gennadiy Goldberg recommended that clients bet against a Federal Reserve interest-rate hike later in the month. The logic was that inflation would likely be benign enough to justify a hold. Equally important, a slew of Fed officials had spent days pushing back against expectations for an imminent move.

Then the data came in hot. Traders quickly ramped up bets on an October hike, at one point putting the odds at roughly 50-50, up from about 20% before the report — and Goldberg and his team began debating whether to abandon their brand-new trade. But almost as quickly as the market moved against them, it started swinging back. By the end of the day, most of that move had been erased. "We didn't even have a chance to take the trade off," said Goldberg, head of US interest-rate strategy.

Several market cross-currents were at play that day to stoke the roundtrip, including a stock selloff, AI jitters and increasing tensions in France. For many, though, it came down to the stream of Fedspeak signaling a pause in October. The seemingly explicit language stood out at a time when Chairman Kevin Warsh has said he wants to wean markets off such "forward guidance."

Caught in the middle, traders fell back on the familiar and took their cue from what policymakers were saying. But they also acknowledge that on its own, the inflation data might have spurred them to wager on an October hike. All of this leaves investors in a precarious position heading into this week's policy meeting, still somewhat guessing and prone to a jolt if their read of the situation turns out to be wrong.

"There's a disconnect between what Warsh has said and what the others have signaled," said Neil Dutta, head of economics at Renaissance Macro Research. "When you have this sort of development or condition, there's always a risk that the market can get whipsawed at any given meeting."

To be sure, recent market developments make the chance of such a whipsaw less likely. With AI shares continuing to slide and concerns starting to build around US growth prospects should the artificial intelligence boom falter, traders now have even less conviction that the Fed will raise rates next week — or even this year. Odds of an October move now stand at less than 15%, based on interest-rate swaps. But it was a different picture just a few weeks ago, when the series of speeches began.