MBS Live cornerstone Andy Pada reminded me yesterday that I was pretty sure the Fed was going to hike in September.  Indeed, I was relatively passionate about the idea.  MBS Live has a new and improved search feature, so I found the conversation in question, and it ends up serving as a good intro for today's thesis.

The reason I was such a believer in the September hike was that I increasingly believed (and still do, to some extent) in the "dry powder" argument for Fed policy.  For the record, this is a controversial topic and one that's looked down on by more than a few traditional analysts, but here's the gist: The Fed considers several different potential paths for the economy.  One of the paths they must consider would indicate a downturn (or 'winter,' as the case may be) is coming some time within the next 3 years.  In fact, that's one of the highest probability paths based on timing and the leveling-off in economic fundamentals. 

By the time you throw China's downturn into the equation, things start looking more and more gloomy for the global economy.  The 'dry powder' argument holds that the Fed would prefer to have "something to cut" as opposed to run the risk of doing more QE in the event an economic downturn justifies policy accommodation.  And what better time to cut than when data had been decent and when the policy rate obviously wasn't having an impact on inflation anyway!  More importantly, what better time than now, because waiting ran the risk of leaving the Fed behind the ball in terms of dry powder prep. 

In hindsight--and only with the benefit of yesterday's Fed Announcement, we can now be fairly assured that September's abstention was a product of China-related uncertainty.  The China stuff was big and new and scary.  The Fed didn't want to "mess up," as it were.  So they thought it would be more prudent to give the China situation a month or so to play out. 

They were obviously much more concerned about China than they let on and they've obviously much less concerned now.  In reading yesterday's announcement, I see a Fed that's every bit as ready to hike as they were in September, but simply felt that they'd be introducing too much of a shock to pull the trigger in October.  In other words, the Fed would have hiked yesterday if they thought markets were even halfway prepared for it.  A December hike is far more likely than Fed Funds Futures suggest, but still not necessarily guaranteed.

The good news about a hike is that the longer end of the yield curve (which speaks more to MBS and mortgage rates) doesn't necessarily take a big hit.  We were able to get a glimpse of this yesterday as shorter term yields got killed while we were only gently maimed.  Heck, best-ex is still in the high 3's.  10yr yields didn't even break their sideways range.  Play defense though.  Winter is coming--whatever that means.