Yellen: hints at rate hike unless the jobs report is very weak
In Friday’s speech, Fed Chair Janet Yellen confirmed that the Fed is set to hike rates at the upcoming meeting ending on 15 March, unless the jobs report for February due on Friday is extremely weak. We probably need to see jobs growth below 100,000, a higher unemployment rate and no improvement in the weak earnings data in January before the FOMC members change their minds. As we expect the jobs report for February to be good, we expect the Fed to deliver and change our Fed call to a March hike (previously June). Markets have priced in an 85% probability of a Fed hike at the upcoming meeting.
It is still a bit surprising to us that the Fed has turned so hawkish so quickly. There were not many signs in neither the last FOMC statement, the minutes from the latest meeting nor Yellen’s hearing in Congress that the Fed was going to hike already in March. It seems as if the Fed considers the meeting as a window of opportunity due to strong economic data, a tight labour market, easy financial conditions and record-high stocks.
Due to the high probability of a Fed hike later this month, the interesting question is how many hikes to expect for the rest of the year. Yellen said in her speech that the hiking pace would be faster than in 2015 and 2016, as the Fed is close to having met both its criteria, in her view. If the Fed continues at the current hiking pace, it would imply four hikes this year, which, however, we think is a bit too much. Although the FOMC members have signalled a March hike, they have also repeated that they think three hikes are appropriate. We expect the Fed to maintain the ‘dot’ signal for this year unchanged at three hikes in the updated projections. It is worth keeping in mind that the Fed is data dependent and will not hike unless data support the case – remember the Fed signalled four hikes during 2016 back in December 2015 but only delivered one.
Still, we raise our forecast and now think the Fed is set to hike three times this year in March, July and December (previously we expected two hikes with risk skewed towards a third hike), as the Fed seems less worried about inflation and has increased its weight on labour market and growth data. We stick to our view that the Fed is only set to hike once in H1 17 but now twice in H2 17 when we get more information about Trumponomics. By hiking at one of the small meetings in July, the Fed shows that it means that every meeting is ‘live’. Markets price in 2.5 hikes this year.
We still expect three-four hikes next year. Markets are pricing in a total of 4.7 hikes before year-end 2018, so there is still room for higher US rates, in our view. We expect the Fed to begin the reduction of its balance sheet in Q1 18.
We want to highlight that it is not without risks to tighten monetary policy at this time. Core inflation is still somewhat below 2% and has not been at or above 2% since April 2012. Both market and survey-based inflation expectations remain low in a historical perspective. Monetary tightening in the US has been a key negative factor for commodity prices in recent years and thus something to watch out for. Commodity prices in general could take a hit if the Fed speeds up the path of normalisation of rates, which could result in a repetition of what happened in 2015 and the first half of 2016.
