Federal Reserve

Market’s response to hawkish Fed rate hike chatter: ‘Show me’

Fed unlikely to raise rates anytime soon: Pro
Fed unlikely to raise rates anytime soon: Pro
Fed strikes hawkish tone: Pro
Fed strikes hawkish tone: Pro

The market is sending a clear message to Federal Reserve officials who say a September interest rate hike is still on the table, according to foreign exchange strategist Boris Schlossberg.

"Basically they're saying, show me," BK Asset Management's head of forex strategy said Wednesday on CNBC's "Squawk Box,"

New York Federal Reserve President William Dudley on Tuesday said it's "possible" the Federal Open Market Committee could raise rates at its September meeting, citing his view that U.S. economic growth will pick up in the second quarter and investors had become complacent in their belief low rates would continue to bolster stocks.

"Certainly the market thinks it's kind of absurd. I mean, the biggest dichotomy in the market right now is what the Fed is saying and what the market is doing," Schlossberg told CNBC, noting the dollar has gotten "destroyed" in the last few days.

The dollar index was slightly higher on Wednesday, but has fallen nearly 1 percent in the last week, a sign traders are not expecting investors to pile into the dollar to buy up U.S. Treasurys ahead of a rate hike.

Federal Reserve Chair Janet Yellen.
Joshua Roberts | Reuters

Market watchers will get a better view into the Fed's thinking when minutes from the July FOMC meeting are released at 2 p.m. ET on Wednesday.

At best, Fed policymakers will strongly signal in September they plan to raise rates at their next meeting in December, Schlossberg said. Echoing a common refrain, he said the Fed is unwilling to risk a "temper tantrum" in the equity markets in the middle of a presidential election season.

The common view is the FOMC avoids making market-moving decisions ahead of elections to avoid the perception it is trying to influence the outcome of political contests.

Karyn Cavanaugh, senior market strategist at Voya Investment Management, said she expects Fed officials to continue to strike a hawkish tone. But she, too, believes a September rate hike is a nonstarter and said a move in December is unlikely as well.

The hunt for yield in a low-rate environment remains the reason stocks continue to grind higher and set records, Cavanaugh said, but if and when the Fed does pull the trigger, a significant gap will remain between the returns investors can expect from equities and bonds.

"There's such a disparity that I don't think it's going to happen right away, so I think that investors are jumping the gun if they think they're going to get ahead of it," she told "Squawk Box."

Before investors rotate back into government bonds, the Fed needs to raise rates continuously over a three- to six-month cycle, rather than in a stop-and-start fashion, Schlossberg said.

The danger in the latter scenario is the Fed loses control of long-term interest rates while they intermittently tinker with short-term rates, he said.