I. FOMC Meeting, Moving Away From Accommodative To Neutral
Hawkish sentiments once again emanated from Fed Chair Jerome Powell last Wednesday as the Federal Reserve unanimously hiked the federal funds’ upper rate by 25bps to 2.00%. The officials’ rate projections indicated a slightly faster path of higher rates with a greater likelihood of reaching the Fed’s neutral rate sooner than expected.
Powell reinforced this sentiment at the post-meeting press conference noting the Fed is nearing its accommodative stance and moving rates more towards a neutral zone. The neutral rate is generally considered the level at which where unemployment remains low, the economy grows and inflation remains stable. The Fed maintained its projection of a long-run neutral rate to be between 2.3% and 3.5%.
On the back of the announcement two-year Treasury yields rose nearly four basis points to 2.57% (then, almost 10 bps higher on the week). Two-year yields were hovering around 2.547% this morning, about 0.4 bps higher than Friday’s close. Moreover, the ten-year treasury yields briefly crept back above the key 3.00% level on the back of the Fed’s statement. The 10-year note opened this morning at 2.913%.
Key takeaways from the meeting included:
- Officials now think the pace of the rate hikes may increase as a majority (eight vs. seven) of officials forecasted a total of four rate hikes in 2018. At the time of this writing, the futures market predicted a higher probability (58% post vs. 50% prior to the meeting) of four rate hikes in 2018.
- As BMA forecasted, the committee bumped up its year-end inflation outlook from 1.9% to 2.0%.
- Officials raised their 2018 growth expectations to 2.8%.
- Unemployment forecasts were revised downward for the next three years. Powell mentioned uncertainty on how low unemployment level may go.
Strong economic activity, low unemployment numbers, increased household spending and business investments all contributed to the Fed’s more bullish economic outlook. Nevertheless, the Fed maintains a watchful eye on the impact of potential tariffs and relatively modest wage growth. Powell noted that while anecdotally the Fed has heard of companies holding back on investments and hiring because of the potential tariffs, the data still seems strong and highlighted tariffs as a “risk” for the committee to consider.
II. Other Central Bank activity:
Unlike the hawkish sentiments from the Fed, the ECB surprised the market with more dovish rhetoric. While the bank provided plans to wind down its bond-buying program by year-end, it intends to keep its key deposit rate at -0.4% at least through the summer of 2019.
- Further, the bank revised its GDP outlook downward from 2.4% to 2.1% while slightly raising inflation expectations to 1.7% (the bank target inflation level is slightly below 2%).
- The diverging monetary policies between the Fed and ECB prompted the Euro to drop against the USD (from $1.1816 to $1.1645) with 10-year German bund yields dropping almost seven bps to 0.423%. The Euro opened higher versus the USD this morning trading at $1.1619, increasing tariff tensions between the U.S. and China partly contributed to the Euro’s upswing.
The BoJ capped the week in terms of central bank activity leaving its key short-term deposit rate unchanged at -.01%, largely due to inflation levels hovering far below the bank’s 2% target.
- The bank also pledged to continue its bond purchases at JPY 80 trillion annually – the BoJ is the last of the major central banks to continue a loose monetary policy.
- The BoJ is expected to release its economic projections next month. Given recent data, many expect forecasts to be revised downwards.
III. Tariffs: Trade tensions escalated towards the end of the week as the Trump Administration announced 25% tariffs on $34 billion of Chinese goods imports and further tariffs on another $16 billion in imports under consideration, to be implemented on July 6. China retaliated by announcing $34 billion of tariffs on U.S. goods. Global equity indices took a hit on the threat of a potential trade war. The S&P 500 ended the week slightly lower around 2,779.
The week ahead:
The focus will continue to be on both trade and central bank policies. With trade tensions between the U.S. and China rising, fears of the U.S. pulling out of NAFTA is of concern for investors. We expect the U.S. to announce its response to China’s tariffs this week. Both the Bank of England and the Swiss National Bank will opine on their monetary policies on Thursday.
OPEC and other oil producers such as Russia are scheduled to meet this Friday to decide on a production output policy. There seem to be tensions simmering going into the meeting, as Saudi Arabia and Russia having spare capacity would be inclined to increase production whereas Venezuela and Iran (particularly given U.S. sanctions) seem to want to hold back supply and support higher prices.
Key U.S. Data includes:
NAHB Housing Market Index (Monday), building permits(Tuesday), housing starts, Redbook index, API crude oil weekly stock, MBA mortgage applications (Wednesday), current account, existing home sales, EIA crude oil stock changes, weekly jobless claims (Thursday), Philadelphia Fed manufacturing survey, housing price index, PMI data (Friday), Baker Hughes Oil Rig Count.
Fed officials scheduled to speak: Raphael Bostic (Monday), John Williams, James Bullard (Tuesday).
Overseas Economic Data includes: Italy trade balance (Monday), AUD Westpac consumer survey, AUD housing price index (Tuesday), AUD RBA minutes, EUR current account, NZD current account, BoJ minutes, JPY all industry activity index (Wednesday), German PPI, CHF SNB quarterly bulletin, NZD GDP, AUD RBA bulletin (Thursday), CHF rate decision, BOE rate decision, EUR consumer confidence, JPY national CPI, French GDP (Friday), French/German/EUR PMI, CAD retail sales, CAD CPI.
