Wednesday, February 28, 2018

Capital Markets: "It Takes Powell to Convince the Market that Yellen was Right"

From Marc to Market:
Many market participants think they heard Fed Chair Powell give a fairly strong signal that he favored a more aggressive course. The implied yield on the December Eurodollar futures rose five basis points to 1.535%. The December Fed funds futures contract rose three basis points.

The market moved not to pricing in a fourth hike this year, but to fully price in the third hike
, which the December dot plots implied. A third hike would bring the effective Fed funds rate to 2.17% and the implied yield of the January 2019 Fed funds futures contract is 2.155%. It took Powell's apparent comfort with a more aggressive path to convince the market of something the Fed's dot plot indicated more than two months ago.

We do not think that Powell will be pleased with the market's reaction. It seemed to misconstrue. He prefaced his comment by saying he did not want to prejudge the FOMC, but that his personal outlook for the economy had strengthened. This is important. What strengthened? Powell's outlook. What does that mean? We think it means that he is more confident that the Fed is on course to reach its mandated objectives.

We continue to believe that the superior strategy here is not to change the dot plot to four hikes this year.
The anti-inflation credibility of the Powell Fed will already be bolstered by a hike at his first meeting as Chair. The Fed need not signal its intention to hike more aggressively. By the June FOMC meeting, the trajectory of prices and the economy will be clearer.

Ironically, a couple of hours before
Powell testified, data were reported that prompted economists to revise down Q1 18 GDP forecasts. Taking the recent softness in housing starts into account as well, the Atlanta Fed GDPNow tracker lowered its estimate to 2.6% down from 3.2% on February 16. It began the month near 5.4%. It is the lowest estimate in four months.

To be sure
, it is not just in the US that the synchronized global recovery has met the New Year. Surveys and sentiment indicators in the euro area warn that economic momentum may have peaked. One exception to a string of mostly softer than expected reports was the February German employment data released today. Unemployment fell more than expected, with the unemployment queues shrinking by 22k instead of the 22k the median in the Bloomberg survey expected. Unemployment fell by an average of almost 16k a month in 2017. The three-month average now stands at a -25.3k, the most since April 2011.

Price pressures remain steady
. Today the preliminary estimate of February CPI was reported at 1.2%, in line with expectations, down from 1.3% in January. Last February headline eurozone inflation reached 2.0%. The core rate was steady at 1.0%. It was steady at 0.9% throughout Q4 17, which is also where it was in February 2017. Progress?

The Japanese economy
practically stagnated in the last three months of 2017. It has begun the new year on weak footing. Consider January retail sales. The 1.8% drop in the month was three-times more than expected and is worth six-month of sales at the average monthly gain in 2017 (0.3%). Industrial output slumped 6.6% in January. It is the largest decline since 2011. The market had expected around a 4% fall after December's 2.9% gain.

China disappointed as well
. ...