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Investors Should Revise their Liftoff Expectations as FOMC Remains on Track to Raise Rates this Year

On Friday, San Francisco Fed President Williams (dove, FOMC voter) and Cleveland Fed President Mester (moderate, FOMC non-voter) both said they expect the FOMC to begin liftoff at some point later this year.

 

According to CNBC, San Francisco Federal Reserve President John Williams believes the U.S. central bank should raise rates twice this year if economic data meet expectations. In the meantime, according to WSJ, Federal Reserve Bank of Cleveland President Loretta Mester said raising rates right now wouldn’t be a problem for the economy as a whole.

 

These two statements confirm that most of FOMC members seem ready to raise rates this year. The fact is that the median dot plot for 2015 remained at 0.625% during the June FOMC meeting. It suggests that the committee expects at least two hike in 2015 despite that the World Bank joined the IMF in urging the Federal Reserve to hold off raising rates until 2016.

 

As suggested by the chart below, the gap between investors’ expectations and FOMC projections remains huge. But if data keeps on improving in coming weeks and Grexit is avoided, investors should revise upward their expectations concerning the pace with which the FOMC will tighten its policy.

 

 

 

FOMC Preview – A Summary from Bloomberg

Aberdeen (Luke Bartholomew)
- Fed will likely use June FOMC mtg to prep for Sept. rate hike and if 2015 and 2016 dots remain unchanged, “then we are full steam ahead for September”

 

AllianceBernstein (Joseph Carson)
- Fed officials would be “well advised to follow their script from the April FOMC statement and begin to lift official rates off the zero bound”
- “A policy that waits for economic data to supply the ‘truth’ will always be looking backward — and will always be systemically late”

 

Barclays (Michael Gapen)
- Improving economic data might allow Fed at this week’s FOMC mtg “to send a message of ‘not now, but soon’ in regard to the timing of policy rate firming”
- Stronger data may prove insufficient for June Fed rate hike, Sept. is most probable date for rate liftoff

 

BNP (Paul Mortimer-Lee)
- SEP and dot plot will likely have a more dovish tone while Fed’s policy statement and press conference may lean more hawkish, leading to an overall bearish message for June FOMC mtg
- Fed will likely show readiness to hike rates; broader message may support BNP’s view that Sept. is most probable month for the first rate hike

 

BofAML (Michael Hanson)
- Fed appears “quite unlikely” to hike in June, and possibility of Sept. rate hike will remain in focus for next week’s FOMC mtg given recent improvement in economic activity
- Fed officials may be “merely watching for reasons it might need to be dissuaded” to hike rates in Sept.

 

Capital Economics (Paul Ashworth)
- June FOMC statement may not have many changes, as “Fed will want to keep its options open,” although Fed may eventually tighten “much more aggressively than either Fed officials or the markets currently anticipate” due to rising wage growth and price inflation
- Slight downward revisions to 2015 GDP growth forecast would not be surprising; inflation, unemployment rate projections will likely be “largely unchanged”
- CapEcon views that Fed will likely begin hiking in Sept., although “a July rate hike is still a possibility”

 

Credit Agricole (David Keeble)
- Yellen can’t afford to sound “too dovish” at June FOMC mtg as employment data and its momentum may be “a poor excuse not to hike”
- CA recommends taking profit on shorts and heading back to neutral if Fed sounds more hawkish, since “any move higher in 2Y rates may be faded in the hours beyond any jump” given proximity to Eurogroup mtg

 

Credit Suisse (Dana Saporta)
“Modest” improvement in economy has likely not been sufficient to prompt Fed to tighten in June, with Sept. remaining most likely date for liftoff and July having a 15% probability
Fed may revise central tendency range for 2015 GDP down to 2.0%-2.4% at June FOMC mtg

 

Deutsche Bank (Joseph LaVorgna)
- Next week’s June FOMC statement will likely “acknowledge that the economy’s underlying momentum remains intact” and keep policymakers on track for Sept. liftoff
- Fed may mark down central tendency of 2015 real GDP growth to 1.7%-2.0% from earlier 2.3%-2.7%

 

Goldman Sachs (Chris Mischaikow)
- Speeches from Fed officials during intermeeting period suggest consensus view has shifted to reflect “that liftoff will likely be appropriate ‘at some point this year’” from a previously held view of 1st hike in mid-2015
- GS expects liftoff in Sept., although there is “a significant risk that hikes could be pushed back to December or later”

 

Jefferies (Ward McCarthy, Thomas Simons)
- FOMC’s median fed funds rate est. would be unchanged at 0.625%
- Avg. 2015 fed funds forecast may drop by 13bps

 

Morgan Stanley (Ellen Zentner)
- Sept. rate increase is “not off the table,” however, “we continue to believe enough uncertainty will linger over the outlook for growth and inflation that the Fed will choose to delay to Dec.”
- Fed statement seen saying economy “has failed to rebound strongly on the back of a very weak start to the year”

 

Renaissance Macro Research (Neil Dutta)
- Importance of this week’s FOMC mtg has largely faded after weak 1Q, although “recent improvement in the economic figures keeps a September rate hike in play”
- FOMC statement will likely point to improving economy

 

Standard Chartered (Thomas Costerg)
- June FOMC mtg may focus on “preparing the ground for a post-summer rate hike” as Sept. remains most likely date for liftoff
- Fed may lower longer-run growth estimates due to “persistently lacklustre productivity data”

 

TD (Eric Green)
- “Constructive” economic data since April mtg may lead to “more upbeat” tone at June FOMC mtg although 2015 economic growth projections will likely be revised lower
- Possible, although not probable, that median dot in 2015 would move down from 0.625% to 0.375%
- TD reaffirms view that Fed will start raising rates in Sept. as “the level of confidence is not yet sufficiently high to do so in June”; July mtg “is best viewed as a set up for higher rates” with follow through in Sept.

 

Source: Bloomberg

The USD Will Pursue its Rally as Investors Underestimate the Pace with which the Fed Will Tighten its Policy

According to the Bloomberg, on January 30, Federal Reserve Bank of St. Louis President James Bullard said investors are wrong to expect the Fed to postpone an interest-rate increase beyond midyear, with the U.S. economy leading global growth and unemployment dropping and noted that:

 

The market has a more dovish view of what the Fed is going to do than the Fed itself…
… Markets should take it at face value from the Fed’s rate projections

 

In this context, I decided to take a look at both Fed fund futures and latest FOMC median forecasts (December) and the fact is that the gap between investor’s expectations and Fed guidance is simply HUGE. As a matter of fact, Fed officials expect the benchmark funds rate rise to 1.125% by the end of 2015 while investors are only betting on 0.410%.

 

 

Of course, Fed’s forecasts seem to be too agressive as they imply four rate hikes for 2015 in a context of 1) CPI’s weakness, 2) global slowdown and 3) geopolitical tensions, but a liftoff by midyear remains the base case scenario. Separately, according to Fed funds futures, investors see only a 15% chance that the Fed will raise its benchmark rate in June.

 

As a consequence, this situation implies that there is still a huge potential of appreciation concerning the USD especially as:

1) ECB will implement QE next month.

2) SNB has an unofficial corridor of CHF1.05-CHF1.10 against €.

3) BOJ will keep on implementing an accommodative monetary policy.

U.S. December Employment Report: Comments from Christophe Barraud

Christophe Barraud, Chief Economist & Strategist at Market Securities, sent me his analysis concerning the U.S. December employment report:

 

1/ NFP surprised on the upside at 252K (11th consecutive months over 200K) vs 240Ke and once again, figures were revised upward in Nov. (+32K) and Oct. (+18K) so that, in 2014, NFP monthly average reached 246K (highest since 1999), up from 194K in 2013. Note that for private employment, 2014 was the best year since 1997. The improvement was broad based with all components adding jobs. Construction sector created most of jobs (+48K) in a context where weather conditions were clearly better after a cold and snowy Nov. which means that housing data should improve in Dec.

 

2/ Separately, the unemployment rate fell 0.2% to 5.6% which is the lowest since June 2008 but also the threshold defined by the CBO as the NAIRU (full employment). This drop can be explained by the significant decrease of the unemployed people (-383K to 8.688M, the lowest since June 2008) and the ongoing decline of the participation rate to the lowest level since 1978 (-0.2% to 62.7%). Once again, figures suggest that, in line with recent findings in academia, this move is mainly due to demographics and not to discouraged workers. The fact is that many of the people exiting the labor force were actually employed in November which means that older workers decided it was time to retire. Here is the breakdown, last month, some 4.4 million Americans went from having a job to being out of the labor force, the highest number since August 2007. That’s twice the 2.2 million who went from being jobless to out of the workforce.

 

3/ Therefore, more entry-level positions (not getting too much paid) and retirements of more expensive employees probably played a role in the decline of wages (-0.2% MoM, the biggest drop since records began in 2006). Separately, we have to keep in mind that stores and online merchants hired a larger-than-usual army of seasonal workers with low salary. Note that in Dec, retail workers saw average earnings fall 0.4% to $17.04 an hour from $17.11 in November. Finally, several economists were particularly cautious about the data. As a matter of fact, Citi and JPM said they believe the distribution of average earnings declines across sectors suggests a broad adjustment error which may well be corrected next month causing a big snap back higher in the data. This scenario seems likely given that several states raised the minimum wage in January.

 

4 / Finally, note that qualitative indicators were also quite strong as:
*underemployment rate fell 0.2% to 11.2% (lowest since Sept. 2008)
*employed part time for economic reasons declined 61K to 6790K (lowest since Oct. 2008)
*long term unemployed decreased by 77K to 2693K (lowest since Dec. 2008)

 

5/ All in all, it was another very strong report but it raised doubts about the current wages’ growth. My guess is that the decline is transitory and we should see a pickup in Jan. The fact is that the labor force is falling while job openings are increasing.  It offers little room for Fed before raising rates. A liftoff in April (in line with Dec. FOMC dots) is less likely given that inflation will remain particularly low in Q1 so that more than ever, June is our base case scenario.