By Michael O’Neill, Agility FX, Senior Analyst
It was nearly two years ago, March 18, 2015 to be exact, when the Federal Open Market Committee (FOMC) dropped “patience” from their policy statement. It was big news. Forecasters, analysts, and the financial media concluded that interest rates in the United States would rise sooner rather than later.
They were bang on, if “sooner” could be defined as eight months. On December 16, 2015, the Fed raised interest rates a quarter point, bumping the target funds rate range to 0.25-0.50 percent from 0.00-0.25 percent. They waited another year before raising the target range again.
When rates were increased in December 2016, the Summary of Economic projections dot-plot forecasted three additional quarter-point increases in 2017. Since then, a host of economic data releases point to a US economy that is growing steadily. The latest inflation reading (Feb.15) showed that January CPI rose 0.6 percent, surpassing the forecast rise of 0.3 percent. That was enough to boost the CME Fedwatch odds for a March rate increase to 31.0 percent on February 15.
A couple of Fed presidents may have helped lift the expectations. Eric Rosengren, President of the Federal Reserve Bank of Boston opined that that the Fed may need to be more aggressive than the median Fed forecast. That’s Fedspeak for more than three rate hikes. However, he doesn’t get a vote.
Philadelphia Fed President Patrick Harker does. He repeated his call for three rate hikes in 2017 and earlier in the month suggested that a move in March was appropriate.
Janet Yellen gave rate hawks a Valentine. In her Semiannual Monetary Policy Report to the Congress, she delivered an upbeat assessment of the US economy. She pointed out that labor market gains have been accompanied by a further moderate expansion in economic activity and noted that consumer spending has continued to rise at a healthy pace. The comment that set the rate hawks screeching was “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”.
The US dollar soared against the major currencies but slammed into a wall shortly afterwards and retraced all its gains and then some. Traders may not have pachyderm recall but being severely burned on false rate hike hopes does leave a mark. A June rate hike was a sure thing in June 2016, until it wasn’t. The same thing occurred in September 2016. Traders can be forgiven for treating Janet Yellen and her colleague’s statements with a healthy dose of skepticism.
Is this time different? Perhaps. Ms. Yellen testified to the Senate Banking Committee on February 14 that the US created an average of 190.000 jobs per month in the second half of 2016 while the unemployment rate declined to 4.8 percent. More telling, is her comment that the unemployment is in-line the Committee’s estimate of its long run normal level. She acknowledged that inflation was rising, although it was still below the Fed’s 2 percent objective while ignoring the January CPI report.
She also said that “At our upcoming meetings, the Committee will evaluate whether employment and inflation are continuing to evolve in line with these expectations, in which case a further adjustment of the federal funds rate would likely be appropriate.”
And therein lies the problem. Ms. Yellen and the FOMC have an economy that has fulfilled the Committee’s requirements necessary for an interest rate increase. The fact that Ms. Yellen expressed concerns about “waiting to long” suggests that the Ides of March may be bad news for interest rate doves.
But maybe not. The US economy may be growing steadily and employment is close to full but there is a fog of uncertainty rolling in from the White House.
On February 9, President Trump promised “we’re going to announce something I would say over the next two or three weeks that will be phenomenal in terms of tax,” In theory, tax cuts will stimulate jobs and growth and capital expenditures. The issue is with 4.8 percent unemployment, there is not a pressing need to stimulate job growth. However, the tax cuts could stimulate the economy while increasing inflation.
Mr. Trump is also talking about a 20 percent “Border Adjusted Tax” as well as other protectionist trade measures. These trade strategies could have a negative impact on the US economy and offset any benefits from a tax cut.
The economic impact of future tax and trade strategies was cited by Ms. Yellen as an uncertainty. It also provides a tailor-made excuse for an ultra-cautious FOMC to bide their time and wait for further economic inputs.
The FOMC may have lost their patience but they replaced it forbearance, tolerance and restraint.
Rate hike?Not so Fast, maybe in five more months Source: Google Images