Traders will tell you that nothing's worse than making the right call but not being able to make any money off of it.
So as the "will they or won't they" debate stretches into the 11th hour, it's a good time to examine how Wall Street expects the market to react to an array of potential Federal Reserve outcomes.
A team of strategists at UBS, led by the co-head of foreign exchange and rates strategy, Themos Fiotakis, identify four general scenarios that could transpire at 2:00 p.m. Eastern Time:
1. Unchanged/dovish: No hike/no change in Fed's communication (most dovish result).
2. Unchanged/hawkish: No hike but a change of language signalling imminent hikes.
3. Hike/dovish: A hike and a dovish communication (hard balance to strike).
4. Hike/hawkish: A hike and a signal of more hikes ahead (most hawkish result).
The market is relatively prepared for situations two and three, UBS's team writes, so these would have a limited effect on price action over the medium term. But the relative surprise scenarios, one and four, would both have a similarly negative impact on longer-dated U.S. Treasuries and send yields higher.
For the most dovish outcome, it's about the message sent regarding the evolution of monetary policy. Not hiking while saying that liftoff wasn't around the corner, or using the dot plot to send the message that a 2015 hike would be an unlikely event, would indicate that the Fed has no plans to snuff out the American expansion soon. This would be supportive of growth and inflation expectations, according to UBS.
"After some initial volatility, the curve would likely steepen, not just via lower front-end rates but also via higher 10-year yields," the strategists write. "In fact, the longer the Fed waits, the more likely a sell-off in long bonds of up to 50 basis points."
At the other end of the spectrum, Fiotakis and his team believe that an unexpected hike with the promise of more to come would cause investors to demand a higher rate of compensation for holding sovereign debt at the long end of the curve.
"Initially, the surprise would likely cause long-end rates to jump higher, as heightened policy and macroeconomic uncertainty commands a higher term premium," write the strategists, comparing this hawkish surprise with the taper tantrum of 2013.
An early hike would perhaps also bring forward the timing of the unwinding of the Federal Reserve's balance sheet, which is chock full of long-dated Treasuries—another potential negative for these assets.
But over the medium term, hikes coming swift and soon would help longer-dated Treasuries catch a bid for the same reason that pushing back the timetable for liftoff would do the reverse—and perhaps prompt investors to start pricing in a reversal of these moves.
"It may even be the case that such an outcome creates risks of even lower inflation rates one year down the line," writes the UBS team. "This could (in the extreme) trigger market expectations of cuts in 2017."