Having to ask younger esteemed colleagues whether they had heard of the above phrase shows how times have changed. Conversely, history tends to repeat itself and it is in this light that ‘Don’t fight the Fed’ seems particularly apt after yesterday’s semi-annual testimony by Janet Yellen.
“Waiting too long to remove accommodation would be unwise, potentially requiring the FOMC to eventually raise rates rapidly, which could risk disrupting financial markets and pushing the economy into recession.” Yellen’s undoubted positive tone during her testimony to Congress resulted in another grand slam of record US equity highs for all four main stock indices. Similarly, the MSCI all-world index is approaching its all-time highs.
Markets also saw more strength in the dollar and U.S bond yields tick up. The realisation of the Fed’s projected three interest rate hikes for this year are certainly attracting the attention of many. Indeed we have had some Fed Presidents recently banging the drum on their commitment to the three hike scenario. For example, Lockhart, Kaplan and Lacker only yesterday all stated that rates should be raised soon.
What is interesting in the current environment is market pricing of rate hikes for this year. The three hike scenario is still only given a 43% chance by the markets. The implied probability of a March rate hike has risen from 30% before her speech to a modest 34%, near to the levels immediately after the December rate increase. The market sees the June meeting as the most likely time for the first hike of this year, with a 73% probability. But this is only up 3% from before Yellen’s speech.
For us, the impact on the dollar is of course key. The greenback has now extended its winning streak to 11 straight days and we are approaching both the 50 day Moving Average and the 50% retracement level from the all-time highs made at the start of the year at 103.42.
For further dollar strength, President Trump’s fiscal plans will be critical. The pro-growth, pro-business agenda targeting above trend GDP and higher inflation has already been evident in the first days of the Administration. More recently, ‘phenomenal’ tax cuts have added another boost to the dollar’s run and it would appear that the positives do outweigh the negatives (protectionism, trade frictions etc) at the moment.
Underlying all of this is the divergence in US growth and interest rate differentials over its economic peers. This is certainly not an alternative fact, so perhaps the ‘Don’t fight the Fed’ mantra will become more commonly used again.