The Week Ahead 12.03.2017: Fed to raise rates this week
Fed is feeling that it is getting too far behind the curve
The Fed is going to raise rates again at the upcoming meeting. And the move has been well telegraphed. Within only a few days, the Federal Reserve completely turned market expectations around and prepared investors for a March rate hike (the odds for a March hike implied by fed funds futures are currently 100%). It all began with Vice Chair Dudley highlighting that the case for tightening had become “a lot more compelling” in recent months. One day later, usually dovish Governor Brainard added, “It will likely be appropriate soon to remove additional accommodation”, and Chair Yellen hammered the message home by stating that “at our meeting later this month, the Committee will evaluate whether employment and inflation are continuing to evolve in line with our expectations, in which case a further adjustment of the federal funds rate would likely be appropriate.” If that was not enough, Vice Chair Fischer told the New York Times, “If there has been a conscious effort to signal a March rate hike, I’m about to join it.”
To be sure, we still don’t know exactly what has caused this sudden change in the Fed’s rhetoric. If anything, the hard data in the previous month indicated that first-quarter GDP growth may be a bit weaker than originally thought, while wage gains softened. Against this backdrop, this sudden eagerness to pull forward the next rate hike suggests that the Fed is starting to feel that it is getting too far behind the curve. In line with that, Chair Yellen began to soften the language with regard to the “gradual” removal of policy accommodation. Not only did she qualify the statement by saying that the gradual removal is “likely” to be appropriate, but went on emphasizing that “unless unanticipated developments adversely affect the economic outlook, the process of scaling back accommodation likely will not be as slow as it was during the past couple of years.”
The updated Summary of Economic Projections is unlikely to show any major changes compared to December. With no new details on a potential stimulus, Committee members will likely continue to project around 2% GDP for the coming years, while the jobless rate will go down to 4.5%, and inflation hits 2% over the medium term.
Amid the aforementioned eagerness to somewhat accelerate policy normalization we expect a further upward shift in the dots – albeit without necessarily moving the median dots, which currently indicate three hikes for each of 2017, 2018 and 2019. But, in particular, the Committee members, who had the most dovish outlook thus far, may have ramped up their interest rate projections towards the median.
BOE to stay cautious as economy is slowing
On Thursday, 16 March, the Bank of England simultaneously publishes the MPC’s monetary policy decision and the MPC minutes from its meeting. We expect the MPC to vote unanimously to leave the stance of monetary policy unchanged.
The background to the March meeting is the February Inflation Report, when the BoE significantly revised up the outlook for demand (on the back of stronger-than-expected economic activity) but also revised up its estimate of spare capacity (by revising down its estimate of the long run equilibrium unemployment rate from 5% to 4.5%), leaving the outlook for inflation little changed. The Committee kept the guidance that policy could move in any direction to changes in the economic outlook.
Crucially, the news on the month suggests the UK economy is slowing. Retail sales fell quite sharply in December and January, consumer credit has eased, regular pay growth eased, and the services PMI fell more than expected to 53.3 in February and now is 1.9 points below its historical average of 55.1.
In the MPC minutes of its February meeting, there were signs of widening disagreement on the Committee, with the minutes noting that, “For some members, the risks around the trade-off embodied in the central projection meant they had moved a little closer to those limits (to the degree to which above-target inflation could be tolerated)”. And, in a speech on 7 February, Kristin Forbes reinforced her hawkish stance by saying, “If the real economy remains solid and the pickup in the nominal data continues, this could soon suggest an increase in bank rate”. Forbes will leave the MPC on 30 June and, given the mounting evidence that UK economic activity is slowing, which warrants a greater tolerance for an inflation overshoot, the chances of dissent by a minority on the MPC later this year have waned.
SNB to stay on hold
On Thursday, 16 March, the Swiss National Bank will publish its quarterly monetary policy decision and monetary policy report. We expect the SNB to leave the target range for the three-month Swiss franc Libor unchanged at between -1.25% and -0.25%, and to keep its policy of remaining active in the FX market.
The main developments over the past three months are:
1. CPI inflation increased to 0.6% yoy in February, more than the SNB forecast; however, as in the euro area, the rise has been driven by energy and food prices while core inflation remains very low, at -0.1% yoy;
2. GDP growth disappointed in the fourth quarter 2016, rising just 0.1% qoq following an upwardly revised 0.1% qoq in 3Q16, and this despite firming global growth;
3. The Swiss franc trade-weighted exchange rate has appreciated around 0.5% since the SNB’s December meeting.
While the SNB will welcome the rise in headline inflation, it will likely emphasize that it is energy-driven and, almost certainly, will maintain its expansionary monetary policy.