Ok, so Friday’s jobs number (you know, the one that Breitbart hilariously described as a “great again, jaw-dropping, sizzling, rocket“) cemented a March hike that was already cemented. Call it “priced-in-er-er-er.”
Additionally, the decent headline number but average-ish accompanying wage print was probably a Goldilocks moment for markets that have recently exhibited a bit of Tantrum-like behavior. That is, we saw a rather dramatic plunge in Treasurys last week heading into Friday and stocks looked like maybe they weren’t quite ready to stomach a sharp repricing higher in yields.
The takeaway: if we’d gotten the blowout print the ADP number suggested we might get, I think it’s entirely fair to say that yields might have exploded higher as traders repriced expectations beyond the March meeting. I’m not entirely sure stocks would have reacted as favorably to that as you might think they would given what a blockbuster beat would have said about the economy.
Anyway, Goldman is out with a preview of the all-important March Fed meeting (how something that’s fully discounted can be “all-important” is beyond me, but c’est la vie) and as the bank notes, “the FOMC has almost always delivered a hike or cut that was highly priced in advance of the meeting.”
But more important than March is Goldman’s contention that the FOMC’s reaction function may have changed. Last March we saw that the Eccles cabal was inclined to take their foot off the pedal quickly at the first sign of trouble (and God knows there was plenty of deflationary trouble during January and February of 2016). Now, Goldman contends, “the FOMC may approach policy decisions more symmetrically, implying a lower hurdle for additional hikes.”
A rate increase at the March FOMC meeting now looks like a forgone conclusion, and market attention has naturally turned to the policy outlook for the remainder of this year. Relative to consensus forecasts and current market pricing, we see the risks as tilted toward further tightening.
First, financial conditions have eased substantially. In effect, there has been only a moderate net change in the impulse to growth from financial conditions in six months, despite a second funds rate increase and a significant steepening in the expected path for the funds rate over the coming years.
Second, incoming activity data continue to surprise on the upside. Our US Current Activity Indicator (CAI) averaged 3.6% over the last three months, the fastest pace of growth since December 2014. While Q1 GDP growth is tracking significantly lower, we are inclined to trust the signal from the CAI, in part due to the global nature of the cyclical upswing.
Third, the decision to hike at the March meeting may indicate a slight shift in the committee’s reaction function. Over the last two years the FOMC appeared to take an asymmetric approach to policy, with a greater willingness to slow the pace of rate increases than to the speed them up. Now that the economy looks much closer to the Fed’s objectives, the FOMC may approach policy decisions more symmetrically, implying a lower hurdle for additional hikes.
We expect the FOMC to make a few changes to its post-meeting statement next week, including indicating that risks to the economic outlook are “balanced”, and signaling that the 2% inflation objective will likely be reached before too long. In the Summary of Economic Projections (SEP) we look for slight upgrades to GDP growth and core inflation, but unchanged median “dots”.
We have also made a few modest changes to our own Fed forecasts. While we continue to expect three rate increases in 2017, we now look for a March hike to be followed by rate increases in June and September (versus September and December previously). In addition, we have changed our forecast for the start of balance sheet normalization: we now expect the committee to announce an end to full reinvestment in Q4 2017, instead of mid-2018.