John Velis, Macro Strategist at BNY Mellon, Expects Fed to Raise Rates Again in December
John Velis, Macro Strategist at BNY Mellon, predicts in a report that the Federal Reserve will raise interest rates again in December, but he is uncertain whether the market's priced-in rate hikes through 2027 will materialize, depending on how effective the current tightening is against inflation shocks.
He noted that if tightening only cools demand without affecting the prices supporting current service sector inflation, the Fed may have to pause next year. Current policies are more about maintaining anti-inflation credibility rather than solely relying on rate hikes to control inflation unless demand is also simultaneously suppressed.
He pointed to components of core PCE that are insensitive to interest rates as drivers of inflation. While he does not oppose further rate hikes and acknowledges that rates may rise for a while, he believes there are many obstacles on the path to higher policy rates, and the trajectory for 2027 remains unclear.
The market has priced in about 100 basis points by the end of 2027, equivalent to four 25 basis point hikes. Velis believes the economy may struggle to endure such restrictive levels for long, and the Fed might consider reversing some tightening in the second half of 2027. Short-term yields may not fall recently, but they may have already outpaced fundamentals.
With low visibility in the Middle East, a calming situation could lead to falling oil prices, potentially reshaping the market's trade-offs with the Fed; he ties the policy outlook to a scenario that may worsen before improving, which he believes is not a long-term solution. Even if energy prices experience a positive supply shock relative to the current situation, traditional demand-driven inflation cannot be ruled out.
Pricing is event-driven path correction. Buyers are betting on a 25 basis point hike in December but are skeptical about the short-term trading positions fully priced in for 2027, while sellers are pricing forward contracts based on about 100 basis points of tightening for the year. Funds are shifting from pricing in rate hikes in 2027 to hedging against ineffective supply shocks; beneficiaries are those who break the path into "one more this year, not necessarily full next year" bond allocations, while those under pressure treat oil prices and the Middle East as a single exogenous variable, fully pricing in all rate hike slopes at once.
Source: Public Information
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Velis has revised his path three times this year: in February, he still called for three rate cuts by year-end; after the Middle East conflict in March, he shifted to a wait-and-see approach; in May, he abandoned two rate cuts within the year, opting to hold until year-end and pushing easing to 2027; by mid-September, he first accounted for a 25 basis point hike this week and then another this year, now writing December's hike as a baseline and suggesting the 100 basis points priced in for 2027 may not materialize. The same person has shifted from "a reopening of Hormuz can lead to cuts" to "rate hikes won't impact supply-sensitive components."
Capital movements follow oil and short-term pricing. Conflicts elevate oil prices and inflation expectations, prompting funds to buy into the federal funds futures rate hike path; he warns that if the Strait reopens and oil prices fall, the same positions will need to reverse. BNY is simultaneously preparing reserve management purchases and balance sheet adjustments, indicating that the interest rate path and reserve levels are being considered within the same macro trading framework, rather than just looking at the dot plot.
Comparing to the ECB and Fed after the 2022 energy shock: at that time, they also initially treated supply shocks as overheating demand, later changing their stance when growth gaps appeared. Bank of America and PGIM had revised their rate hike outlook to three times within the year in June, expecting a return to cuts in 2027. Velis is in a middle position of "acknowledging further hikes, but denying the ability to fully hike," with the industry phase indicating that pricing for supply shocks is not yet over, while demand destruction begins to enter models.
Structural changes indicate a shift in pricing power. Policy rates cannot extract oil or reopen straits, yet they are still used to sign off on inflation expectations. The mechanism is: once interest-sensitive demand is suppressed, if remaining inflation is still supported by energy and non-interest-sensitive services, the curve will shift from pricing "number of hikes" to pricing "timing of pullbacks after rate hikes become ineffective." Whoever first removes supply shocks from the Taylor rule will be the first to sell the 2027 rate hike premium.
ABAB News · Cognitive Law
- Rate hikes won't reopen the strait.
- Market pricing of hikes does not equal the economy's capacity to withstand them.
- Tying policy to war will lead to instability in the path.