US: FOMC on track to raise rates

Markets focused heavily on policy speeches given in the US this month. The first came with President Donald Trump delivering a more measured, positive and optimistic message for his first Congressional address. Despite being relatively light on detail he reiterated his commitment to a pro-growth policy agenda – of which the key tenets were tax reform centred on corporate and household cuts, deregulation and infrastructure spending. Defence spending and immigration reform were also reaffirmed as key policy priorities, while the President also seemingly softened his language around potential trade barriers, highlighting “fair” trade rather than imposing undue restrictions. The President’s more conciliatory tone on policies that potentially pose larger medium term economic risks left markets relatively comfortable. And consequently the rally in equity markets that occurred through February and early March was well supported.

There was also a positive narrative coming from the US Federal Reserve centred on preparing markets for a near term interest rate hike. A chorus of regional Fed governors suggested a near-term rate rise would be appropriate. This came as further progress is made towards the Fed’s key economic mandates and global economic conditions remain supportive. On the former, the last three months of payroll data have averaged 187,000 new jobs per month and the unemployment rate has remained below 5%, averaging 4.7%. Whereas inflation, in headline, ‘core’ and consumption deflator terms, has accelerated to 2.5%yoy, 2.3%yoy and 1.9%yoy, respectively, according to the most recent data.

The President’s more conciliatory tone on policies that potentially pose larger medium term economic risks left markets relatively comfortable.

Importantly the chorus of supportive voices included Dallas Fed President Robert Kaplan and Philadelphia Fed President Patrick Harker, both of whom are new Federal Open Market Committee (FOMC) voters in 2017. New York Fed President William Dudley arguably made the most transparent remarks suggesting “the case for monetary policy tightening has become a lot more compelling”. And even Fed Governors Lael Brainard and Jerome Powell, who have previously remained relatively dovish, seemed to be supportive of ongoing policy normalisation. US Federal Reserve Chair Janet Yellen echoed her committee members’ sentiment. Yellen suggested that outside of any disastrous payroll data preceding the meeting the Fed would evaluate whether employment and inflation were continuing to evolve in line with expectations, “in which case a further adjustment of the federal funds rate would likely be appropriate”. Markets and economists broadly agreed her statement was the strongest indication yet rates would be raised at the Fed’s March meeting, leaving the central bank on track, as reflected in its “Dot Plot”, to increase rates three times this year.

US: Unemployment & inflation
Continued progress with the Fed’s mandate


Source: IFM Investors, BLS

Messages from both the White House and the Federal Reserve have for now left markets comfortable with both the notion of “reflation trade” for now and that we are now edging past an inflection point in the global economic and monetary policy cycle. However, the timing of any further fiscal policy stimulus will be important if the current accelerated momentum in the reflation trade is to be maintained. It would therefore be unsurprising if we see a pullback, but not an outright reversal, should policy timing and/or content expectations disappoint.