The Market Today
BoE Holds After Fed Hikes, Markets Await Announcement on China Tariffs
by Craig Dismuke, Dudley Carter
Initial Claims Inched Up But Remain Strong and Continuing Claims Dropped to Lowest Level Since 1973: Yesterday in his post-meeting press conference, Fed Chair Powell said job growth has continued to run well above the pace needed and followed that with “We expect the job market will remain strong.” Another uneventful jobless claims report extends a solid trend that should continue to support that expectation. Initial claims rose just 3k last week to a still-solid 229k while continuing claims the week before dropped 57k to 1.828MM, a new low dating back to December 1973. The labor market continues to be the most consistent component of the economic data set and strength in hiring is one of the major fundamentals underlying the improved outlook for economic growth.
Later this morning, the FHFA House Price Index is expected to show a 0.4% MoM increase in January which would help nudge the YoY rate back above 6.6%. In addition, Markit’s latest PMIs for the U.S. are expected to show marginal improvements in March, the Fed’s leading index is expected to add 0.5%, and the Kansas City Fed’s Manufacturing Activity Index is expected to remain unchanged at 17.
Also in focus for Thursday is the expectation that the White House will announce tariffs aimed at China. Earlier this week, Chinese officials indicated they could respond to any trade interference with measures of their own, sparking fears of an escalation of trade tensions between the two major economies. In addition to the continued digesting of yesterday’s Fed decision, trade concerns may weigh on Wall Street Thursday.
Yesterday – Yield Curves Steepened Lower after Fed Placed Higher Dot in 2019: As expected, the Fed’s rate decision was Wednesday’s major focus. Prior to the afternoon announcement, energy companies lifted the major stock indexes as energy commodity prices rallied on a surprise draw of U.S. crude inventories. Despite the data also reporting another record-high for U.S. production, WTI front month contracts rose nearly 3% to take its two-day tally to just over 5%, the strongest since December 2016. The Treasury curve was little changed but slightly steeper heading into the announcement. As is customary, markets flipped back and forth after the Fed announcement as investors digested changes to the Statement wording and the updated rate path and economic forecasts. By the close, asset classes reflected differing takeaways. Treasury yields and the Dollar, which initially popped higher, both closed lower on the day signaling a more dovish interpretation. The 2-year yield fell 3.9 bps while the 10-year yield dropped 1.3 bps. Stocks initially rose, but fell back during Powell’s testimony and closed modestly lower, implying a more hawkish takeaway.
Overnight – BoE Leaves Rates on Split Decisions as Investors Reflect on Fed Decision and Await China Tariff Announcement: U.S. assets picked up Thursday where they left off following the Fed’s rate hike and call for an incremental increase (now three total) in 2019. Solid economic forecasts and additional rate increase seemed to unnerve equities and U.S. futures are notably weaker again with the Nasdaq leading all declines. However, the decision didn’t seem to meet the bond market’s most-hawkish scenario and the Treasury curve bull steepened Wednesday with shorter-yields pulling back the most. Overnight, the Treasury curve is flatter as longer-yields played catch-up (10-year -4.9 bps) while shorter yields held steady (2-year -1.4%). The Dollar remained weaker but is off the lows following a pullback in the Euro. The euro area’s currency weakened after a slew of PMI’s from the region missed estimates. On a consolidated basis, the Eurozone’s composite PMI dropped more than expected to its lowest level in 14 months (since January 2017). In the U.K., the Bank of England voted 7-2 to keep its target rate at 0.5%, projected a similar outlook for growth and inflation, believes Brexit remains the biggest risk for the economy, and continues to expect “gradual” and “limited” rate increases over the forecast period will be warranted.
Fed Hikes and Sees a Stronger Outlook Requiring More Hikes Further Out: The FOMC voted unanimously to hike rates for the sixth time of this cycle, bringing the target Fed Funds range up to 1.50-1.75%. The Statement noted the weaker start to 2018 (“moderate” economic activity rather than “solid”, “household spending and business fixed investment have moderated from their strong fourth-quarter readings”), but an improved outlook going forward (“The economic outlook has strengthened in recent months.”). On inflation, the Statement pointed to inflation firming up in “coming months” rather than “this year”. The economic projections were somewhat confounding in that they noted faster growth (GDP: 2018 – 2.5% to 2.7%, 2019 – 2.1% to 2.4%, 2020 and longer run – unch.), an even tighter labor market (UR: 2018 – 3.9% to 3.8%, 2019 – 3.9% to 3.6%, 2020 – 4.0% to 3.6%, longer run – 4.6% to 4.5%), but just a 0.1% uptick for core inflation in 2019 (2.1%) and 2020 (2.1%). Powell attempted to reconcile this in his comments by pointing to “the flatness of the Phillips curve”. As a result of the stronger outlook, the dot plot reflected more hikes in out years but still three hikes in 2018. However, the median dot now forecasts three hikes (to 2.875%) in 2019 rather than two, a year-end 2020 rate of 3.38% instead of 3.06%, and a longer run rate of 2.9% instead of 2.8%. Powell said the 2020 rate forecast was “modestly restrictive” but “highly uncertain…honestly, I wouldn’t put too much on that”. Bottom line: The Fed expects growth to be notably better than they believed in December. They expect the labor market to tighten even further and inflation to move back to their 2% target sooner than they did in January. However, they continue to expect inflation to remain moderate, allowing them to continue on a gradual path of policy normalization.