The Fed is set to increase rates in March – earlier than previously expected
A hawkish tone was communicated by several Fed officials (including traditional “doves”) during the past week and, more importantly, by Fed Chair Yellen on Friday. Indeed, comments included references to a potential rate hike at the March 15 meeting, barring any negative surprises in the labor market report (due on March 10).
As a result, the probability increased for a March hike, with markets assigning a 96% likelihood (versus 50% a week ago). Markets now price in two hikes in 2017, and assign a 50% probability for a third hike, thus coming closer to FOMC projections.
US President Trump, in his address to a joint session of Congress, reiterated his plans for a $1 tn investment in infrastructure (financed through both public and private capital), but provided little detail on tax policy. His tone was more conciliating than usual, raising expectations of a more harmonious policy debate in the US.
The ECB meeting on Thursday is expected to upgrade its inflation forecasts, at least for 2017 (currently 1.3%), in view of the recent increase in headline CPI (2% for the first time since January 2013, see graph). The ECB will have to strike a balance between better economic data (consistent with less dovish rhetoric) and subdued core inflation pressures.
In China, the annual 10-day National People’s Congress started on March 5, during which economic, social and policy goals are communicated. Authorities appear willing to accept a more sustainable, albeit lower, pace of growth as they continue to reduce overcapacity in various industries (steel, coal). Fiscal policy will remain proactive (fiscal deficit target of 3% of GDP) with monetary policy broadly neutral (strong TSF target, appropriate liquidity conditions, unchanged benchmark rates).
According to the Government report delivered at the opening of the Congress, the target for real GDP growth in 2017 is set at “around 6.5%”, from an actual 6.7% in 2016 (and a target of “6.5% - 7.0%”), and the target for domestic credit growth, as measured by total social financing growth (TSF), at 12% yoy from 12.8% yoy in 2016 (and a target of 13% yoy).
Emerging markets underperformed (-0.6% wow / +5.6% ytd) on the back of expectations for higher US rates and a stronger USD (+0.7% wow in NEER terms).
The S&P 500 rose 0.7% wow, reaching record highs intra-week, while the EuroStoxx gained 2.6% wow, finding further support from fading French political concerns. In both cases, banks were the key players (+2.5% wow and +8% wow, respectively), on the back of higher government bond yields. On Monday, euro area banks lost some ground, as DB announced that it will raise c. €8bn in new capital.
US Treasuries (USTs) sold off, due to the re-pricing of the Fed’s monetary policy tightening path, with 2-Year yields up by 16 bps wow to 1.31% (the highest since June 2009) and 10-Year yields up by 17 bps to 2.48%. German Bunds followed suit, with 2-Year yields up by 15 bps to -0.80% and 10-Year yields up by 17 bps to 0.36%.