While US economic data was rather mixed in the week ending Friday 3 March 2017, closely followed speeches from the country’s two most important policy makers (i.e. President Trump and Chair Janet Yellen of the Federal Reserve) took centre stage and dominated market action. The bottom line was an 8-year high for two-year Treasury yields and a new all-time high for the S&P 500.
The backdrop of economic data once again underlined the stark contrast between subdued hard activity data and strong confidence surveys. To start with, Q4 GDP growth was unrevised at just 1.9% quarter-on-quarter (QoQ) saar and real personal spending in January disappointed market expectations with a drop of 0.3% month-on-month (MoM). Some of this weakness is possibly related to the slow start in tax refunds and solid price increases as headline personal consumption expenditures printed at 1.9% year-on-year (YoY), but the momentum in real personal consumption has clearly slowed over the last few months. Moreover, the trade deficit was wider than expected, durable goods and construction spending were weak, and auto sales slowed. At the same time, survey data remains strikingly optimistic. Business confidence as measured by the composite ISM suggests real GDP growth of above 3% YoY and Conference Board consumer confidence picked up to the highest level in 15 years.
Trump’s speech was more presidential in tone but also scant on specifics and lacked any legislative time frame
This balanced data flow allowed investors to keep their eyes on Washington where President Trump addressed the joint session of Congress. The speech was scant on specifics and lacked any legislative time frame, but two points inspired markets to a positive interpretation. First, his tone was perceived as more presidential and, second, Trump emphasized job creation, lower taxes, fair trade, infrastructure investments, military spending and de-regulation. Whether and when he will be able declare success on these fronts remains to be seen, but the convoluted calendar of Congress suggests that it will, at the very least, be a longer path for him to go in order to eventually “walk the talk”.
Fed communication now strongly suggests a rate hike in March
In addition to Trump’s remarks, a set of Fed speeches fuelled market volatility as rhetoric clearly shifted into hawkish territory. Board Governor Brainard noted that “it will likely be appropriate soon to remove additional accommodation” and Board Governor Powell thought that “the case for a rate increase in March has come together”. Furthermore, Fed Chair Yellen had the last word before the Fed’s blackout period began on Friday and struck an overall hawkish tone, arguing both that the economy is operating near or at capacity and that a too slow withdrawal of monetary accommodation now risks a more disruptive tightening cycle further down the road. It almost appeared as she was telegraphing a decision effectively already made by stating that at the next meeting (on 14-15/3/17) the Federal Open Markets Committee (FOMC) will likely conclude that “a further adjustment of the federal funds rate would likely be appropriate” if the economy evolved as expected.
The signalling is unambiguous: the FOMC targets the next step up in rates for March. The revival of animal spirits and the easing in overall financial conditions since the election, to which the strong rally in equity markets has markedly contributed, are probably two of the main drivers for the renewed urgency. Everything short of a disastrous disappointment in the labour market report on 10/03/17 should be the final piece in the puzzle for the Fed and allow them to “walk the talk” at their next meeting on 14-15 March. Markets agree and are pricing a rate hike probability of above 90%.
Exhibit 1: Probability of a 25 basis points rate hike at the FOMC meeting on 14-15 March 2017, as priced by fed funds futures contracts
Written on 7 March 2017