US Economy, Politics, Policy Rate & Dollar
Forecast “However, very skinny market pricing of 8-9bp of [Fed] hikes for the remainder of the year may not sit that well with the FOMC. I would therefore expect some kind of verbal intervention by Chairperson Yellen and other FOMC members to push up market pricing closer to around 15bp to help keep the odds of a December rate hike alive.” [We know what you did last summer, 1 September 2017]
Outcome Market pricing of rate hikes for the remainder of 2017 dipped to as low as 6.5bp in early September but then gradually rose to 13.5bp and jumped to 16bp following the Fed’s 20th September policy meeting.
Forecast “The big question is what next for the Fed. Its updated forecasts and dot-chart and Yellen’s question-and-answer session [at the 15 March policy meeting] will undoubtedly provide some extra colour. But it may be a little premature for the 17 FOMC members to materially change their forecast for the appropriate pace of hikes for 2017, which stands at 74bps – broadly in line with current market pricing.” [Fed 25 and 500 Godfathers, 10 March 2017]
Outcome The 17 FOMC members’ median forecast for rates hikes in 2017 was unchanged at 75bp while the weighted average edged only slightly higher to 78bp from 74bp.
Forecast “Whether or not Trump is true to his word, my view is that the burden of proof is and will likely remain on the doves to show that a rate hike is not warranted and my core scenario is that the Fed will hike its policy rate 25bp on 15 March 2017 for the second time in three months.” [March Madness, 17 February 2017]
Outcome Fed hiked 25bp, contrary to market pricing in mid-February of only a 23% probability of a hike and an overwhelming analyst consensus forecast of no hike.
Forecast “Nevertheless, if Trump and his team fail to provide a more detailed roadmap for the US economy, markets’ good-will may flounder and the Dollar and US equities may correct lower.” [Market Fatigue in the face of catastrophic success, 20 January 2017]
Outcome President Trump has so far provided few details or timelines for the introduction of his much-vaunted and arguably pro-dollar electoral pledges of cutting taxes and boosting infrastructural spending, instead focussing on immigration issues and re-negotiations of trade agreements. Dollar NEER weakened 3% between 20 January and early May 2017.
Forecast “Trump’s election has turbo-charged expectations that reflationary US-centric policies will drive global, and in particular US growth and inflation in 2017, that the Fed’s hiking cycle will step up a gear and that US yields and equities and the dollar will climb further, heaping pressure on emerging economies and asset prices. But analysts and markets may now be getting ahead of themselves.
My core reasoning is that US inflation may not rise as fast expected, due to lags in the implementation of Trump’s planned fiscal policy loosening and immigration curbs, residual slack in the US labour market and disinflationary impact of higher US yields and a stronger dollar. As a result, the FOMC, which will see important personnel changes in early 2017, may argue that the market has already done some its work and not be as hawkish as expected […]. If, as I expect, the eurozone economy starts to benefits from the euro’s depreciation and US yields stabilise or fall, this yield spread may no longer be sufficient to push the EUR/USD cross lower”. [Hawkish pendulum may have swung too far, 21 December 2016]
Outcome US core CPI-inflation gradually slowed to 1.9% yoy in April 2017 from 2.1% yoy in Q4 2016 and GDP growth slowed to a 3-year low of 0.7% qoq (annualised) in Q1 2017. In the month following publication of my research note, US 2-year yields traded in a narrow 10bp range of 1.14-1.26% and 10-year yields fell about 10bp to 2.44%. Market pricing of Fed rate hikes in 2017 fell from about 61bp on 21 December to 52bp on 19 January 2017. The US Nominal Effective Exchange Rate (NEER) and US equities were broadly flat while EUR/USD slowly rose from a multi-year low of sub-1.04 on 21 December 2016 to 1.08 in mid-March 2017 and 1.10 in early May.
Forecast “[…] the dollar NEER – which is now only down 1% year-to-date – could end the year stronger, as per my January forecast of a third consecutive year of albeit more modest dollar gains.” [Federal Reserve – the Father Christmas of central banks, 23 September 2016]
Outcome USD NEER appreciated 5% between 23 September and end-2016, and was up 4.5% in 2016.
Forecast “Recent US data have likely put a Fed rate hike at its 21 September policy meeting beyond reach, with a post-US presidential election rate hike now the more feasible scenario. Labour market data for August – sandwiched between very weak ISM prints – suggest that there is still slack in the US labour market […]. Path of least resistance is probably for the Fed to keep rates unchanged this month while keeping alive the possibility of a hike on 14 December” [Fed sense of déjà-vu, 7 September 2016]
Outcome Fed kept rates on hold in September 2016, pointing to labour market concerns, and hiked in December 2016.
Forecast “The Fed is not down, however, thanks to decent earnings, income and spending, a pick-up in most inflation measures in April and a robust housing market, which all point to a rebound in US GDP growth in Q2.” [Fed on the ropes but not down, 7 June 2016]
Outcome US GDP growth in Q2 2016 rebounded to 1.4% qoq (seasonally adjusted annualised) from 0.8% in Q1 2016.
Forecast Markets […] may be relying on an incomplete and arguably inaccurate picture of US labour market which fails to fully take into account a still sizeable pool of available workers. Job creation has been robust in recent years […] but ratio of the working-age population employed in full-time jobs, currently 48.7%, remains well below its historical average and […] points to private sector earnings growth only rising modestly in coming months from around 2.4% yoy. Policy implication is that Fed may not have to worry near-term about a tight labour market boosting […] wage-led inflation […] Labour market may not provide the platform for higher US policy rates near-term.” [US economy not at full employment, 13 May 2016]
Outcome Pockets of weakness in US labour market contributed to a number of FOMC members (including Brainard) opposing hikes and Fed kept rates on hold in June-November 2016 and again in January 2017. Pool of available labour – unemployed, part-time workers and those not in labour force but wanting to work – remained quite high by historical standards in H2 2016 at over 41 million. This likely weighed on modest weekly earnings growth of only 2.2% yoy (0.7% in real terms) and 4% yoy aggregate weekly payrolls growth (2.5% in real terms).
Forecast “The Federal Reserve is unlikely to hike its policy rate from 0.25-0.50% at its 16 March 2016 meeting and may have little choice but to revise down its expectations to around 3 hikes for 2016 in its accompanying projections.” [Fed – This is what it sounds like when doves cry, 8 March 2016]
Outcome Fed kept rates on hold at March meeting and weighted-average of FOMC members’ expectation for the number of rate hikes in 2016 was cut to 2.6 from 3.6 at December 2015 meeting.
Forecast “Scenario 3: Fed hikes once or twice in 2016. Probability: High.” [What if the Fed hikes, leaves rates on hold…or cuts, 29 January 2016]
Outcome Fed hiked once in 2016 (in December).
Forecast “FOMC members’ median expectation is four 25bp hikes this year […]. Analysts and finance experts have a more dovish view, forecasting respectively 75bp and 30bp of hikes. The market is only pricing in 40bp of hikes – or one full hike and a 60% probability of a second hike. By definition someone will be proven wrong and I would argue that it will again be the FOMC […]. I expect dollar appreciation to extend to a third consecutive year [in 2016] even its gains are likely to be more modest. Market pricing of Fed rate hikes is very slim so FOMC members could halve their expected number of rate hikes without conceivably having a material impact on the dollar.” [What to expect in 2016 – same, same but worst, 19 January 2016]
Outcome USD Nominal Effective Exchange Rate (NEER) appreciated 4.5% in 2016, versus 12% in 2015 and 10% in 2014, despite FOMC members cutting their forecast of appropriate hikes in 2016 from 91bp at December 2015 meeting to 28bp at September 2015 meeting and delivering only one actual rate hike (in December 2016).
Forecast “This scenario […] would still narrow the gap between the Fed and BoE policy rates to only 12.5bp (from 37.5bp currently). This seems broadly appropriate given US and UK economic fundamentals.” [US Slow Sizzle, UK Slow Boil, 3 December 2015]
Outcome Gap between Fed and BoE policy rates was cut to 12.5bp in December.
Forecast “Risk is tilted towards market having to once again push out its expected start date for the Fed hiking cycle [having priced in July 2015 a 1-in-3 chance of a September 2015 Fed hike].” [Pound-for-pound, Sterling still quite cheap, 17 July 2015]
Outcome Fed kept rates on hold in September and hiked on 16 December 2015.
Forecast “I would go a step further and expect Fed to make only small tweaks to its economic and Fed fund rate projections and for Yellen to not say much beyond the Fed remaining data dependent and the rate hiking cycle to be gradual.” [Fed says it best when it says nothing at all, 17 June 2015]
Outcome Fed meeting provided few surprises, making only minute changes to its inflation and unemployment forecasts and only slightly lowering its appropriate policy rate targets for 2015-2017.
Forecast “A stronger USD will, all other things equal, reduce US imported inflation and potentially competitiveness and export growth. At the margin this is more likely to push back rather than bring forward any Fed monetary tightening, in my view […]. Further USD appreciation may see the Fed and US Treasury intensify calls for its major trading partners to support their currencies or at least not pursue policies that weaken their currencies. But I think there is little the US will or can do.” [What to look out for and expect in 2015, 23 December 2014]
Outcome Federal Reserve did not hikes rates until December 2015 and USD Nominal Effective Exchange Rate (NEER) appreciated 12% in 2015.