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Fixed-Income Insights

While a tightening move by the U.S. Federal Reserve on March 15 is not widely anticipated, these three events could quickly change the odds.  

 

In Brief

  • We believe the March 14–15th policy meeting of the U.S. Federal Reserve (Fed) should be considered “live” in terms of the possibility of another 25 basis-point interest-rate hike.
  • While market indicators currently suggest a one-in-three chance of a Fed tightening, we think three events in the run-up to the meeting could influence the probability of a rate hike in March:  

            1) Details from President Trump on his economic agenda in a speech to a joint session of Congress on February 28;

            2) The March 1st release of a key inflation report that is closely followed by Fed members; and

            3) The U.S. jobs report for February, set for release on March 10.

  • The key takeaway— If the Fed does not raise rates in March, its previous projections of three rate hikes in 2017 suggest a strong possibility that it will move at the next policy meeting in May.


The Ides of March—a notable date for Julius Caesar—also may hold significance for financial markets this year. We believe the conclusion of the two-day policy meeting of the U.S. Federal Reserve (Fed) on March 14–15 should be considered “live” in terms of the possibility of another 25 basis-point interest-rate hike. And while we don’t have the admonition of a genuine Shakespearean soothsayer informing our judgment, we have what may be the next best thing: detailed commentary from Fed policymakers.

Let’s start at the top. In Fed chairwoman Janet Yellen’s mid-February testimony before the U.S. Congress, she adopted a more hawkish tone, which was evident in her remarks that recent economic data suggest that “labor market conditions continue to strengthen and inflation is moving up to 2%.” In other language that could be supportive of a March rate hike, her prepared comments warned that “waiting too long to remove accommodation would be unwise, potentially requiring the FOMC [Federal Open Market Committee, the Fed’s policy-setting arm] to eventually raise rates rapidly, which could risk disrupting financial markets and pushing the economy into recession.” 

Such concerns have been reinforced by other Fed officials, including San Francisco Federal Reserve Bank president John Williams, who advised, “If we wait too long…we hazard allowing imbalances to grow, requiring us to play catch-up.” Similarly, voting FOMC member Dallas Federal Reserve president Rob Kaplan suggested that moving “sooner rather than later” would “reduce the likelihood the Fed will get ‘behind the curve’ and feel the need to remove accommodation more rapidly.”

To be sure, while we think there is a significant possibility of a rate hike at the Fed’s March meeting, it is by no means a certainty. While there is clear concern within the Fed that the central bank may act too late, other voting members, including Minneapolis Fed president Neel Kashkari, believe that there is more “room to run” before raising rates further. Even Yellen balanced her hawkish remarks with concern about the uncertainty surrounding the economic outlook, especially as it may be affected by fiscal and economic policies whose content and timing is yet unknown. 

A March rate hike, then, seems dependent on evidence of continued economic growth and inflation, combined with a better understanding of potential fiscal policies and confidence in their impact.  Fortunately for Fed policymakers, before their March meeting they will have three key events that could tilt their decision: President Donald Trump’s address to the U.S. Congress on February 28; the March 1st release of data on the U.S. core personal consumption expenditures index (PCE), a key inflation gauge; and the U.S. jobs report for February, set for release on March 10.  Here, we’ll look at what each may augur for the March 14–15th policy decision.   

Trump Addresses Congress (February 28)
As President Trump’s first appearance before either the U.S. House or Senate, this televised presentation before a joint session of Congress is expected to outline legislative plans and priorities. House Speaker Paul Ryan (R-WI) described the speech as an opportunity to hear about Trump’s “vision and our shared agenda.” The inclusion of the content and timing of pro-growth policies in this address should allow FOMC members their first chance to factor fiscal policies into the economic and rate forecasts that are part of their March meeting. To the extent that fiscal policies seem likely to accelerate growth and inflation in 2017, the Fed may favor a March rate hike rather than waiting. If policies or their economic impact seem likely to be delayed, the Fed also may opt to delay its monetary policy move.

U.S. Core PCE (March 1)
At 2.5%, the headline U.S. Consumer Price Index (CPI) for January was the largest 12-month increase in nearly five years. Even core CPI, which excludes food and energy prices, rose 2.3%, spurred by increases in rents, air fares, and apparel. The Fed’s preferred inflation measure, core PCE, was more contained, at 1.7%, below the Fed’s inflation target of 2.0%. Year-over-year core PCE averaged 1.4% during 2015, 1.6% in the first seven months of 2016, and about 1.7% since August 2016, according to statistics from the U.S. Department of Commerce. A rise to 1.9% or higher in the March 1st release could increase the likelihood of a rate hike in March, while a repeat of a 1.7% reading would support Fed doves in delaying a policy move.

U.S. Employment Report (March 10)
No single release embodies the Fed’s dual objective of maximum employment and price stability like the monthly jobs report. It provides both a comprehensive view of changes in employment—including a breakdown by economic sector, an update of the average workweek, and the workforce participation rate—and average hourly earnings (another key inflation indicator). 

With January’s report showing an unemployment rate of 4.8%, and only 1.4 applicants for every open position, according to the U.S. Labor Department’s Job Opportunities and Labor Turnover Survey, an increase in total nonfarm employment similar to the fourth-quarter 2016 average of 150,000 may be sufficient to assure FOMC members that growth in employment continues to be on track. A decline from January’s 2.5% year-over-year increase in average hourly earnings may delay a March rate hike. However, a return to a rate of 2.8% or higher could support a policy shift, especially if accompanied by a nonfarm payrolls rise closer to 200,000.

Et tu, Janet?
While Trump’s address to Congress, the PCE release, and the Employment Report may have an outsized influence on the Fed’s March decision, other factors could be influential. As we have seen at past meetings, shifts in global growth, heightened concerns about Italy or France leaving the eurozone, extreme currency movements, or an economic surprise in China could all override domestic considerations at the March FOMC meeting. 

However, the biggest consideration may be transparency. Yellen’s desire seems, first and foremost, not to take markets by surprise but to meet expectations. The market currently is not expecting a rate hike in March. As of February 23, fed funds futures indicated a 34% likelihood of a rate hike at the March meeting, according to Bloomberg. In December 2015 and December 2016, when the Fed hiked rates, the moves were about 80% priced-in. The data points discussed earlier could increase investor expectations by March 15, the date of the Fed’s decision, but without some “moral suasion” from Yellen (80% probability may be difficult to achieve). Expect, then, some further Fed commentary if March proves not just “live” but “active.” Otherwise, if three rate hikes in 2017 are still on the Fed’s agenda after standing pat in March, the next FOMC meeting in May becomes a serious contender.

 

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