Think back to last month.
I know that’s really f*cking hard because with Trump in office, each week feels like two years, but do your best.
You may recall that one of the arguments I and others made regarding the outlook for the Fed, revolved around the extent to which financial conditions looked entirely different following the December 2016 hike than they did on the heels of “liftoff” in December 2015.
The 2015 hike was squeezed in amid mounting China worries. The PBoC had just telegraphed further RMB depreciation by introducing a new trade-weighted reference basket and by the time the March 2016 meeting rolled around, it was pretty clear that the world was not ready for a hawkish Fed. Indeed the “Shanghai Accord” confirmed that what markets needed was a weaker USD – at least in the short-term.
As it relates to financial conditions, consider what Deutsche Bank said late last month:
The reaction of financial conditions to an initial round of tightening determines how much further the markets will allow the Fed to go. In this regard it is instructive to contrast the reaction of financial conditions to the year-end 2015 and 2016 rate hikes. When the Fed first raised rates in 2015, financial conditions were already restrictive. A strong bout of further tightening ensued after lift-off, with equities falling by more than 10% to their trough in mid-February. This riskoff trade, combined with rapidly diminishing Fed expectations, caused the curve to bull flatten. By contrast, the 2016 hike occurred when financial conditions were relatively benign, and they have eased modestly further after the hike.
The following table shows the attributions of the changes in our weekly FCI to its various components. None of the components has changed meaningfully since last December’s hike, including importantly the dollar. By contrast, at the same time last year, approximately 3% dollar appreciation exacerbated the tightening effect of the equity sell-off.
Well, fast forward a month and we’re still having the same conversation with regarded to the timing of the next hike (assuming there is a next hike).
While the economic data, a meandering dollar, and record high stocks seem to argue for imminent normalization, there are very real concerns regarding the extent which the reflation narrative is real and the extent to which it’s a figment of the market’s imagination predicated solely on the empty promises of a would-be demagogue.
With this as the backdrop, consider the following excerpts from a piece by Nordea’s Martin Enlund who notes that financial conditions are probably conducive to a hike regardless of what Trump says or doesn’t say.
As we await President Trump’s speech this week and Fed Chair Yellen’s response(?) on Friday, let’s first note that the market puts a 40% likelihood of a Fed rate hike in March (WIRP), and is pricing in ~42bp worth of rate hikes per year between now and January 2020. All this fretting about specific meetings is however fairly irrelevant in terms of broader market trends.
Remember that what matters for economic activity are financial conditions (the combination of the dollar, equities, spreads, and so on), not only the policy rate. Financial conditions are actually the easiest since September (chart 1).
But doesn’t the Fed need clarity from Team Trump (Wednesday) on fiscal easing before turning more hawkish? Not really. The current mix of financial conditions & growth prospects is more benign than at the Fed’s December meeting, and most indicators suggest a strong growth bounce is in the pipeline.
If the Fed didn’t commit a policy mistake in December, it should seek to tighten conditions even more today than it did December– but it has done the opposite by letting markets ease conditions. In this light, Trump shouldn’t need to unveil concrete stimulus options for the Fed to talk up rate hike prospects.