Stronger than expected recent data do not compensate, in our view, the drag represented by uncertainty over fiscal policy. For the time being, our baseline scenario continues to contemplate stable rates in March……
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Yellen’s Congressional testimonies held no surprises, although they were interpreted by the market as relatively hawkish, also in combination with the release of generally strong activity and inflation data. The economic scenario outlined by the Fed Chair is positive, and signals that the two goals of the Fed’s mandate, i.e. full employment and inflation at 2%, are now at hand. Yellen reported that the FOMC expects growth to continue at a “moderate pace”, although she reasserted that the scenario is subject to “considerable uncertainty”, tied to “fiscal policy and to other policies in the US, to productivity growth and to developments abroad”. No news came from the monetary policy front, either. Yellen said that the Fed expects to continue removing monetary stimulus. For what concerns timing, Yellen left open the dates of the next moves, saying that “at the next meetings” the FOMC will assess whether the evolution of the economic picture is in line with forecasts: if so, “a further adjustment of the fed funds rate would probably be appropriate”. This “generic” statement was qualified by specifying that “the economic scenario is uncertain and monetary policy is not on a predetermined course”. In particular, “changes to fiscal policy or to other policies could alter the economic scenario”, and it is as yet too soon to know which changes will be carried out and what their effects will be. Lastly, with regards to balance sheet management, Yellen said that the reinvestment policy will be decided based on the “strength of the recovery”; in the meantime, the Fed will discuss the viable alternatives for the reduction of its asset portfolio. The many speeches delivered by FOMC participants confirmed that opinions differ on the expected number of rate hikes in 2017, and further information will become available with the publication of the meeting minutes on 22 February. For now, in our view Yellen has not greatly changed the message sent at the January FOMC, indicating that rates are on an upward path that will be determined by the evolution of fiscal policy and economic data.
What new information do we have on these two crucial fronts? For what concerns data, over the past two weeks activity and prices both surprised on the upside on several occasions. As regards activity, data confirmed that the manufacturing sector is recovering, at an even faster pace than expected, although the Philly Fed’s surge to its highest levels since 1984 should be viewed in perspective, and associated in part to the volatility of regional surveys. The Atlanta Fed’s GDP Nowcasting points to GDP growth of 2.4% q/q ann. in 1Q 2017, in line with the expected trend: data are positive, but do not incorporate, for now, a “leap”. For what concerns the acceleration of inflation in January, energy played a major role (+4% m/m). The acceleration of the core CPI to +0.3% m/m was driven by core goods (+0.4% m/m, with clothing and apparel also sharply on the rise after a series of contractions) and by transportation (airline fares +2% m/m). Services ex-energy were up by 0.3% m/m, in line with the trend; specifically, primary residence and healthcare prices were up by 0.2% m/m. The Cleveland Fed’s Nowcasting forecast of the core deflator is +0.2% m/m in January and 0.1% m/m in February. Although it is hard to distinguish a trend from monthly volatility, for the time being there is no indication of an upward thrust of prices, as also confirmed by the pricing intentions outlined by business surveys.
As regards the prospect of fiscal expansion, based on the latest information, the wait could be longer than currently priced in by the market. Trump has said that he will soon unveil a plan to repeal and replace Obamacare in early March, and will subsequently work with Congress to have a proposal to reform the tax code ready over the summer. This is important news: if the tax plan is discussed and presented at the earliest in the summer, it is unlikely to be approved before the autumn, which means that the expected fiscal expansion will not have effects, in the best of cases, before mid-2018.
For now, in our view, the balance between economic data and uncertainty over fiscal policy affords more weight to the latter, which at the moment seems to provide the main reason to postpone the next rate hike to a later meeting, beyond March.
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