Sunday, February 19, 2017

"Week Ahead: Number One Rule of the Game is Stay in the Game"

From Marc to Market:
The week ahead is short on economic data and long on anticipation.  It could make for some choppy price action.  The dollar's uptrend of the first part of the month yielded to corrective forces last week, though the greenback finished the week on a firm note.  Even among dollar bulls, the near-term outlook for the dollar is not clear.  However, many, including ourselves, remain bullish over the medium-term.  

President Trump is expected to provide details of his tax plan when he addresses both houses of Congress at the end of the month.   Remember, many economists has argued that the border adjustment would "automatically" send the dollar sharply higher.  Also, lowering corporate tax schedules may get the headlines, but it is the effective tax rate that is key.  Will loopholes by closed?  Will it be revenue neutral, as scored by nonpartisans such as the Congressional Budget Office (CBO)?  Will debt servicing remain tax deductible?  

We are persuaded that the reason that capital expenditures are not more robust is not that interest rates are too high or that businesses do not have access to capital.  Therefore, even if tax reform boosted after-tax profits, it would not necessarily boost investment or growth or employment. It would more likely boost returns to shareholders by funding share buyback programs and dividend payouts.  

The US President bemoans the poor economy he inherited.  The New York Fed's GDP tracker see Q1 growth a little more than 3%, while the Atlanta Fed's model is a little below 2.5%.  The point is that after a little disappointment in Q4 16, when the US economy appears to have grown at what the Fed regards as the sustainable pace (~1.8%), the economy appears to have re-accelerated.  Practically every economic report last week, including consumer prices, retail sales, and industrial production, and the Empire and Philly February surveys, were above expectations.  

The Fed's leadership--Yellen, Fischer, and Dudley--sounded increasingly confident about the trajectory of the economy and prices.   While a March hike may seem soon, but May is looking particularly interesting.  As we have argued, the Fed is a bit hamstrung by its own transparency measures.  It has regularly scheduled quarterly press conferences, which are used to explain policy and policy views (economic projections).  In effect, this halves the number of "live" meetings to four. As the pace of normalization is poised to accelerate, it is clearly in the Fed's interest to re-animate, as it were, the other half.  

To do so requires the Fed to raise raises at a non-quarterly meeting, and May is next to such opportunity.  Others are drawing the same conclusion from the Fed's comments, especially Yellen's testimony.  Last week, the implied yield on the March Fed funds futures contract ticked up one basis point to 0.69% yield.  The implied yield on the May contract rose 3.5 bp to 0.785%.  The June contract's implied yield rose three basis points to 0.85%....