Federal Reserve: Election-year hikes and long-end rates risks – TD Securities

TD Securities strategists maintain that Federal Reserve decisions in election years are primarily driven by economic data, rather than political considerations. They caution that deliberately avoiding a rate hike for political reasons could lead to increased long-end rates and inflation swaps, particularly if markets begin pricing in a near-full hike during the October meeting while the Fed remains on hold.

Historically, election years have not shown a strong correlation with the Fed taking more or fewer actions, as they continue to rely on data-driven decisions. In meetings closest to Election Day, 70% of instances resulted in a hold, with the remaining 30% comprising hikes or cuts. The rationale behind not hiking due to political concerns over midterms could potentially drive long-end rates and inflation swaps higher if the Fed is perceived as being unwilling to raise rates to combat inflation.

If the markets persist in pricing in nearly a full hike by the October meeting without further guidance, and the Fed continues to hold, investors might infer that the Fed's decision was politically motivated if Jerome Powell does not offer a satisfactory explanation during his press conference. As the Fed remains data-dependent, any unexpected positive economic data could lead to a market concerned about a potential reacceleration in the labor market.