Revving up for Fed action

Domestic economic momentum has been re-established, the UK shock has been distributed through global financial markets with little apparent consequence for the US, resource margins have mostly been eliminated, and inflation is on a modest incline. A 25 basis point higher nominal funds rate, even a 50 basis point higher one, by year end keeps the real federal funds rate negative and monetary policy accommodative even as it reassures investors that the Fed has not mislaid the keys to the monetary-policy-tightening machine.

We think that Chairwoman Yellen accedes to tightening this year because she recognizes that a one-quarter-point hike reminds the world that the Fed is on duty and reassures her colleagues that they are all on the same page. As for timing, Fed planners probably gravitate to December. For the dovish Fed leadership, an action postponed might never happen. Waiting until December gets a free look at the election results, which are surely material to understanding the other sources of policy impetus in 2017 and beyond. Any committee hurt about delaying in September can be salved by reporting in the Summary of Economic Projections that the preponderance of the FOMC prefers a one-quarter point higher policy rate at the end of the year, making the dots matter. After all, if they are willing to publish that, they are virtually contracting on a December move.

Vincent Reinhart – Standish, a BNY Mellon company

Domestic economic momentum has been re-established, the UK shock has been distributed through global financial markets with little apparent consequence for the US, resource margins have mostly been eliminated, and inflation is on a modest incline. A 25 basis point higher nominal funds rate, even a 50 basis point higher one, by year end keeps the real federal funds rate … read more

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Central bank clarity fades

The clear blue water of policy divergence that became apparent in the final quarter of 2015 now seems muddied.

The European Central Bank (ECB) suggested that the marginal efficacy of monetary policy is declining when ECB President Mario Draghi stated at the 10 March press conference that its scope to cut interest rates further is limited. Market reaction to comments from the Federal Reserve (Fed) has flip-flopped, with the central bank being viewed as decidedly dovish in April and subsequently hawkish in May.

While the Fed is currently expected to hike rates this summer in response to stronger data, any stumble will produce a strong counter trend and the narrative will change once again. Ultimately, central banks respond to economics. The potential schism in economic paths has created unusual currency reactions over the first half of 2016 and these could well continue.

We would note that the EUR/US$ is at the top of its recent trading range. In addition, investor positioning appears to have switched to short US$. In this environment, we believe a tactical opportunity to short EUR/US$ has been presented. There is also a case to be long the US$ given the more hawkish tone from the Fed.

Paul Lambert – Insight Investment, a BNY Mellon company

The clear blue water of policy divergence that became apparent in the final quarter of 2015 now seems muddied. The European Central Bank (ECB) suggested that the marginal efficacy of monetary policy is declining when ECB President Mario Draghi stated at the 10 March press conference that its scope to cut interest rates further is limited. Market reaction to comments … read more

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Is the S&P 500 in for a prolonged plateau?

Historically, we have seen a few indicators from the Federal Reserve (Fed) for forecasting stock market returns. One of these was positive stock returns in the day or two surrounding the release of Federal Open Market Committee meeting minutes. A less-watched indicator is particularly interesting – one from the St. Louis Fed, which it publishes on its ‘Fred’ website.1

The St. Louis Fed’s adjusted monetary base chart is a favourite of inflation hawks, aghast that the monetary base has quadrupled since 2008, increasing $3.1 trillion from the Fed’s massive quantitative easing.2 If you plot the recent history of S&P 500 returns against the monetary expansion over the past few years, it makes an artful case for QE-induced asset price inflation. Since the Fed ended its QE party, the monetary base has been relatively flat; will the S&P500 returns flatten with it? 3

Jason Lejonvarn – Mellon Capital, a BNY Mellon company

1: https://research.stlouisfed.org/fred2/

2: The adjusted monetary base is meant to reflect changes in demand due changes in reserve requirements of the relevant depository institutions.

3: While the adjusted monetary base has varied over the last two years it is now at the same level it was in early March 2014, $3.9 trillion.

Historically, we have seen a few indicators from the Federal Reserve (Fed) for forecasting stock market returns. One of these was positive stock returns in the day or two surrounding the release of Federal Open Market Committee meeting minutes. A less-watched indicator is particularly interesting – one from the St. Louis Fed, which it publishes on its ‘Fred’ website.1 The St. … read more

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Policymakers’ March missives may burn bondholders

With market expectations for future US interest rate hikes increasingly diverging from the median forecasts of Federal Reserve (Fed) members, something is going to have to give.  Recent concerns over global growth and inflation outlooks and the negative spillover effects to financial markets have caused expectations to be lowered to just about one 25bp hike over the remainder of 2016.  Bond markets are likely to be disappointed by policy makers who we expect to maintain a more optimistic view of the economy and thus continue to communicate their expectations for several rate hikes later this year.

The Fed is unlikely to raise rates following its March meeting, choosing a cautious approach to rate hikes in response to the disappointing growth in Q4 2015 as well as heightened growth risks globally. While it is likely the Fed lowers their forecasts for rate hikes over the course of the year, we believe they will do so modestly. Recent indicators for growth show a rebound in Q1 2016 and, importantly, measures of core inflation as well as the unemployment rate are already at or near the Fed’s year-end forecasts. As the Fed reaffirms their forecasts for multiple rate hikes in 2016, we see scope for rates to rise across the curve which will disappoint bondholders expecting continued low rates.

Robert Bayston –  Standish, a BNY Mellon company

With market expectations for future US interest rate hikes increasingly diverging from the median forecasts of Federal Reserve (Fed) members, something is going to have to give.  Recent concerns over global growth and inflation outlooks and the negative spillover effects to financial markets have caused expectations to be lowered to just about one 25bp hike over the remainder of 2016.  … read more

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US rates – raise, hold or bust?

Recent volatility has been driven by Greece-related events, but we expect the focus will soon shift towards expectations related to the US Federal Reserve (Fed) and whether they will begin their interest rate hiking cycle in September.

We note US economic data is continuing to strengthen as we head into Q3, with jobs, wages and inflation all showing positive signs. Based on the strength of the labour market and our expectation of rising core inflation in the second half of the year, we believe the Federal Reserve will hike short-term interest rates by 25-50 basis points between its September and December 2015 meetings. At present, the Fed funds futures market is pricing in less than a 50% probability of a September rate hike and about a 38% probability of two rate hikes in 2015.

In the short-term we expect this to create some volatility and distortions in asset classes such as credit and emerging markets debt and we look to maintain headroom to take advantage of opportunities in this space.

Raman Srivastava – Standish, a BNY Mellon company

Recent volatility has been driven by Greece-related events, but we expect the focus will soon shift towards expectations related to the US Federal Reserve (Fed) and whether they will begin their interest rate hiking cycle in September. We note US economic data is continuing to strengthen as we head into Q3, with jobs, wages and inflation all showing positive signs. … read more

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