US: Making America confident again

For much of the last month or so the upward momentum in US financial markets has begun to wane. This is particularly true in equities markets - in which significant optimism was being priced in around fiscal stimulus being introduced by the new administration in its first 100 days in office. But its recent unsuccessful bid to push through policy reform on healthcare (at least to date) and ongoing negotiation around tax reform has shaken market confidence. This pause in market gains is now reflective of a more measured outlook including delays to fiscal stimulus.

Consequently, many have speculated that the “Trump trade” – and reflation thematic – has run its course. While the former may be true to some extent, we think the latter has only just begun. The “Trump trade” merely enhanced market confidence that the US was recovering – a trend that had emerged before the election of President Donald Trump. Ongoing positive signs of US recovery leave us comfortable that the reflation theme will continue.

That said, bond yields may not push materially higher for structural reasons. However, the retracing of massively accommodative monetary policy should not allow them to plunge to historic lows again.

This recovery should allow the US Federal Reserve to continue raising official interest rates with confidence. Indeed last month came the first of the three rate hikes the Fed expects to implement in 2017. The increase saw the target range for the Fed funds rate move higher by 25bps to 0.75-1.00%. Fed members’ communications since that decision would suggest they think more tightening of policy will be warranted in the relatively short term. Added to this the Fed is now communicating around the shrinking of its balance sheet (as bonds mature but no reinvestment takes place). This gradual winding down is not likely imminent, but the Fed is seeking to condition the market well ahead of time as to not introduce undue volatility when it does occur.

Despite this the Federal Open Market Committee (FOMC) is clearly proceeding with some caution, March’s hawkish posture unchanged from the beginning of the year. Indeed markets had priced in a more hawkish FOMC communication and sold off when it failed to materialise with most concluding it was a ‘dovish’ hike. Its stance was also underscored by one FOMC member dissenting on the hike, with Minneapolis Federal Reserve Bank President Neel Kashkari voting to leave the rate unchanged. His dissent continued into the commentary by FOMC Chair Janet Yellen, who cautioned in the post-meeting press conference that “...the Fed Funds rate does not need to rise much to get to neutral” and that “the economic outlook is highly uncertain”.

Ongoing positive signs of US recovery leave us comfortable that the reflation theme will continue.

Nonetheless, risks to the economy are still being judged to “appear roughly balanced”. Consequently there were no material changes to the FOMC’s forecast outlook. Importantly core PCE inflation was still expected to reach 2% by 2018; the median long run unemployment rate projection was taken down 0.1pp to 4.7%; and 2018 GDP growth was revised slightly higher 0.1pp to 2.1%. All other forecasts were unchanged.

US: Consumer & business sentiment
The new administration has bolstered confidence


Source: IFM Investors, ISM, Conference Board, NFIB

Improved confidence has been reflected in spades in recent survey data. And it is seemingly the political environment that has, to date, been responsible for this uplift. Consumer confidence (the Conference Board measure) had been trending higher over a number of years, since it troughed during the ‘great recession’. Yet it stagnated through much of 2015-16 only to be revitalised after the US election - climbing 25% since October, and hitting a 16-year high in the March data (this is in stark contrast to sentiment in Australia that has been stuck below average since the global financial crisis and punctuated by reversals caused by the political environment).