Now or in December? Data are ok, we are not all 100% sure yet but… should we wait until December? Hmm, Trump president, data might be worse, lots of international risks like Spanish elections, referendum in Italy or Brexit going wrong…our credibility…hmm…
Few words about current developments:
- The market expectations for a rate hike in Sep are around 20% and 50% for Dec but we should more see it as either a dovish hike or hawkish no hike. Meaning Fed will either hike but will have dovish comments or will not hike and will refer to Dec with some wording about data dependency…etc.
- Apart from present market risk related to uncertainty and very low predictability of Fed’s actions market is watching underlying data to get some hints about economic growth, inflation and employment. As the economy is getting closer to full employment, the GDP and CPI/PCE numbers are gaining importance.
- Steepening of the yield curve at longer end – we may see it as market reshuffling over to shorter term maturities based on rate hike expectations.
- Division of the FOMC officials – of course as always is the case.
Our expectations:
- Our base view is one hike in Sep and eventually second one in December if data support.
- The GDP growth may not be at the level all Fed officials would like to see, eventually we may have a different picture after elections but the economy is overall growing and doing well.
- The question about full time employment is also off the table as almost all FOMC members share the same view that the economy is close to full employment with unemployment rate at 4.9% vs 4.8% (Fed’s full employment rate).
- The only question is inflation - the headline PCE and core PCE. The Fed’s projections show expectations at 1.9% for 2017 and 2% for 2018. The last figures were at 0.8% and 1.6% y/y respectively.
- As the inflation is lagging the economic growth and monetary actions, we see that the rise of prices is on the right track. Do not forget about still very low oil prices, that housing market is stabilizing and that the costs of medicare will not be a huge contributor to PCE due to administrative measures in place.
- All in all – data is good enough to support the September hike, restore the credibility of the Fed, confirm its data dependency and independence ahead of US elections as well as avoid another round of confusion as we had witnessed last year
- Fed officials will likely avoid facing the risks of no hike this year (as per risks described on top of the page) and vote for a 0.25% rate hike from almost a zero level what is from a historical perspective completely irrelevant level
- By gradual hiking (starting in Sep) they will create a room for rate cuts if necessary, to face recession risks in the future. Doing that will also allow to push away discussion about negative rates in US.
- From a completely different perspective a rate hike would mean the beginning of the return to normal monetary policy, breaking the dependence on central bank funding, pushing for fiscal and structural reforms, and more innovation
- The reaction of the markets – let’s have a look at S&P 500. There is something strange going on as US stocks should be much lower to our taste before a rate hike. Is Fed cooking something for us?
- The rate hike may be a confirmation for the markets that the US economy is doing well. Of course the initial reaction will be a small pullback that will be followed by a strong rally.
- In case of no hike, we can see a stop hunting rally and a huge sell off after. Exactly the opposite to what markets are expecting at the moment.
Good luck Champs!
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