A Fed Rate Hold Would Be ‘Unprecedented’ With Rate Hike Odds Above 90%, Says BofA's Mark Cabana

• According to Cabana, a hawkish decision could trigger a twist-flattening of the Treasury curve, with two-year yields rising while longer-term yields decline.
• The BofA analyst added that a 50-basis-point hike would be a major surprise because he does not believe the entire FOMC is aligned with it.
• He also noted that oil had become a key driver for global rates, with higher crude prices raising concerns about broader inflation.

Bank of America (BofA) analyst Mark Cabana said Wednesday that a decision by the Federal Reserve to hold interest rates steady later today would be “unprecedented,” even as markets price in more than a 90% chance of a rate hike.

“If this [no rate hike] happens, it would be unprecedented historically,” Cabana said in an interview with CNBC. He noted that, since 2007, he has not seen the Fed hold rates when markets were pricing in such a high probability of a move.

According to him, the more likely outcome is a 25-basis-point hike, but the market reaction will depend heavily on the Fed’s communication.

U.S. equities moved higher in pre-market trade on Wednesday. The SPDR S&P 500 ETF (SPY) was up 0.40%, the SPDR Dow Jones Industrial Average ETF (DIA) gained 0.37%, and the Nasdaq-100 tracking Invesco QQQ Trust (QQQ) moved 0.62% higher. On Stocktwits, retail sentiment around SPY improved to ‘bearish’ from ‘extremely bearish’ territory over the past day.

What Happens If The Fed Hikes Interest Rates?

According to Cabana, a hawkish decision would reinforce the Fed’s “impatience” with inflation and suggest another hike could come in October or December. Cabana said that could trigger a twist-flattening of the Treasury curve, with two-year yields rising roughly 5 to 10 basis points while longer-term yields fall by a similar amount.

“The long end likes orthodoxy,” Cabana said. “It likes standard monetary policy making. It likes central banks that are raising rates when inflation is high.”

A 50-basis-point hike, meanwhile, would be a major surprise for the rates market and could produce a sharper version of the same move. Cabana considers that outcome unlikely because he does not believe the entire Federal Open Market Committee (FOMC) is aligned with it.

He also expects a hawkish 25-basis-point hike that could benefit equities by putting downward pressure on longer-term borrowing costs.

Oil Keeps Bond Investors Cautious

Oil prices remain another key variable for the rates market. Cabana said global rates are now more closely correlated with oil movements than with underlying economic data or economic surprises. “Oil is back in the driver’s seat,” he said.

According to him, higher oil prices raise concerns for fixed-income investors that inflation could spread through the economy, making them more reluctant to extend duration despite elevated Treasury yields.

The Federal Reserve is set to announce its FOMC rate decision later today at 2:00 p.m. ET.

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