March left market participants with more questions than answers as an adjustment
to monetary policy and a failed healthcare bill could not break Treasury yields out of
recent ranges. Indeed, the FOMC decided to go ahead with another quarter point of
policy tightening this month, but did not offer clear guidance on their subsequent
policy plans. This policy uncertainty kept investors on the defensive, keeping risk
assets and Treasury yields range bound. On the U.S. fiscal policy front, President
Trump’s first foray into legislative negotiation yielded mixed results as the Republican
effort to repeal and replace the ACA fell short as the GOP could not whip the final
5-10 votes necessary to pass the bill in the House. This confluence of uncertainty
from all facets of American policy could continue to cloud the global macro picture
and keep the investment community on their collective heels until visibility improves.
Following a whirlwind end-of-February press tour which saw nearly all FOMC
members make public statements in support of a March policy tightening, the FOMC
pushed the policy rate 25bps higher at the conclusion of their March policy meeting.
Despite broad based approval for the rate hike within the committee, Minnesota
Fed President Neel Kashkari dissented in favor of an unchanged stance. President
Kashkari notwithstanding, the policy statement released following the meeting was
reasonably upbeat, voicing a view of an economy expanding at a moderate pace as
the labor market continues to strengthen and household spending continues to
rise. FOMC members also indicated that they believe inflation is on the right track,
suggesting it had increased enough to characterize it as “close to the committee’s
2% target,” adding that they will continue to monitor developments relative to its
symmetric inflation goal. While this introduction of the symmetric inflation goal
verbiage into the statement was new, the idea of a symmetric inflation goal is
something that Chair Yellen and other FOMC officials have stressed many times
before. This explicit reference to the symmetric inflation goal is simply a reassurance
that the Fed will not react too aggressively if core inflation were to drift somewhat
above 2%.
In support of their view that inflation was trending in the right direction but was
not yet a cause for concern, the committee boosted the core personal consumption
expenditures forecast for 2017 from 1.8% to 1.9% but opted to leave 2018 and 2019
forecasts virtually unchanged. In addition, the median forecast of the fed funds rate,
affectionately known was the “dot plot,” for 2017 and 2018 were left unchanged
at three tightenings expected for each year. The 2019 forecast was revised upward slightly though, as the median committee member now
expects what would equate to 3.5 hikes in 2019 to reach a
rate of 3.0% versus December’s 2.875%. Similar changes
were made to the long run or terminal rate which is now
seen at 3.0% versus 2.9% in December. For the remainder
of the committee forecasts, the growth rate was left virtually
unchanged with the exception being an increase in the growth
forecast for 2018 from 2.0% to 2.1% and a reduction in the
natural rate of employment to 4.7% from 4.8%. Remarkably,
despite the increase to the federal funds rate Treasury yields
and the U.S. dollar both plunged in the aftermath of the
FOMC meeting as market participants were looking for a
more hawkish message and economic forecast mix than
the one they received. Indeed, so pronounced was the asset
market reaction that financial conditions eased markedly for
the day, effectively undoing the policy tightening the FOMC
had just levied.
Roughly half an hour after the statement’s release, Fed Chair
Yellen took to the podium for her quarterly post-meeting
press conference to deliver additional thoughts on policy.
As is frequently the case, the chair delivered an even handed
assessment of the economy, opining that monetary policy
was still accommodative but the FOMC was closing in
on their inflation and employment mandates. The Chair
was also vague on the future prospects for balance sheet
normalization, but did indicate that whenever they were
ready to get balance sheet reduction the process would be
both gradual and predictable. Furthermore, Chair Yellen once
again declined to provide any specific comments pertaining
to the new administration or potential policy responses to any
fiscal stimulus but did indicate some FOMC participants have
“penciled in” fiscal adjustments.
While Chair Yellen and her colleagues were planning the next
steps for monetary policy, their fiscal policy counterparts on
Capitol Hill were at work drafting a healthcare bill to replace
the Affordable Care Act. Since the ACA became law in 2010,
House Republicans have voted to repeal it 59 times but
never got the chance to offer their own alternative. When
finally given the opportunity to present a law of their own
this month, the bill failed to make it to the House floor
as Republican Party members could not agree on some of
the legislation’s finer points. Although President Trump’s
decision to tackle health care as his first major policy initiative
may seem questionable, it remains an important first step
towards large scale tax reform. Without replacing the ACA
with something cheaper, President Trump will have a more
difficult time passing meaningful legislation due to Senate
rules and CBO scoring criteria. Along those lines, there were
nearly $600bn in tax cuts in the healthcare repeal effort
financed by significant reductions in Medicaid outlays.
Without the Medicaid cuts to “pay for” this lost tax revenue, it
will be hard for President Trump and Speaker Ryan to produce
a tax reform plan of the originally planned $3tn size that will
be deficit neutral beyond a 10y horizon.
As the first quarter of the year draws to a close, investors are
still left without clear guidance on the future policy tightening
path for the FOMC or what to expect from the Trump
administration. If the FOMC is to be believed, it would appear
their modal outcome for 2017 is three policy tightenings with
a risk that as many as four hikes may be realized. However,
given the market’s reluctance to price in more than 2.5 or
so tightenings for the year, it appears investors will force the
Fed to actually make good on their forecasts for once before
making any major changes in investment stance. Similarly,
it appears as if the initial “Trump Trade” euphoria has died
down and any further gains will most likely have to come
as a result of delivered results and not intended progress.
Regardless of whether the bull or bear case is delivered,
global asset markets remain in “show me” mode suggesting
sideways price action could continue until concrete progress
is made in one direction or another.
Source: Bloomberg
TSY Yield Curve Across Maturities
Source: Barclays Live
Source: The Federal Reserve
Source: The Federal Reserve
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