Fed to maintain ‘dot’ signal for this year at three hikes
In our view, the February jobs report removed the last obstacle for a Fed hike on Wednesday, in line with the message Fed Chair Yellen set in her recent speech, see also our Flash Comment here.
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 last metering nor Yellen’s hearing in Congress that the Fed was going to hike already in March.
We do not expect any major changes to the statement, as not much has happened since the last meeting.
We expect the Fed to maintain the ‘dot’ signal for this year at three hikes in the updated projections. Yellen said in her speech that four hikes is likely one too many, as it would make monetary policy neutral instead of accommodative, see Tweet.
We expect the Fed to hike three times this year (March, July and December) and three-four times next year. We expect the Fed to begin the reduction of its balance sheet in Q1 18 (see also slide 4).
Fed still awaits more information about ‘Trumponomics’ but previous meetings have revealed that ‘almost all’ FOMC members think there are upside risks to growth due to the expectations of more expansionary fiscal policy. We have not got new information on Trumponomics since the meeting but the Fed has communicated it wants to offset more expansionary fiscal policy by increasing the hiking pace.
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 in 2016 back in December 2015 but only delivered one. After the Fed turned more hawkish, we have seen a drop in the oil price, lower inflation expectations and a small selloff in the US equity markets – perhaps a small sign that the Fed has turned too hawkish, too quickly.
Markets have fully priced in a Fed hike this week – 50% probability of another hike in June
Repricing of Fed
Markets have fully priced in a Fed hike this week. Note that markets price a 50% probability of another hike in June.
Markets price in 2.7 hikes this year and nearly a total of five hikes before year-end 2018.
We think it is difficult to see a more hawkish pricing of the Fed at the moment, though we expect the Fed to deliver one or two hikes more by the end of 2018 than currently priced.
One trigger for a harder Fed pricing could be that the Fed begins to signal four hikes this year, which, however, we think is unlikely given Yellen’s comments in her speech.
The Fed will soon begin to discuss reinvestment strategy
‘Quantitative tightening’ is becoming a market theme
FOMC members have become more vocal on their desire to reduce the Fed’s balance sheet in recent months and the minutes from the last meeting revealed that the Fed should begin to discuss ‘the economic conditions that could warrant changes’ in the current reinvestment strategy ‘at upcoming meetings’.
The Fed wants to begin the reduction when the normalisation of the Fed funds rate is ‘well under way’, which seems to be when it is around 1.50% (half of the Fed’s estimated neutral rate at 3.00%).
We think the Fed will begin the reduction in Q1 18. An NY Fed survey shows that primary dealers expect it to begin a bit later in mid-2018.
Macro charts
Growth rebounded in H2 16 after a slowdown in H1 16
Private consumption the main growth engine
Have investments bottomed out? We think so
Higher US oil production and rig count suggest a rebound in oil investments
Still a bit more slack left in the labour market
Fed sees the world through the Phillips curve
Global business cycle has turned – synchronised recovery signal across regions
Financial conditions are easy
Actual PCE core inflation still below 2% target
Inflation expectations have rebounded but are still low
