On March 15th, the Federal Reserve pulled off the seemingly impossible. They raised the target for the fed funds rate by 25 bps to 75 bps - 100 bps and made everyone think they were almost dovish! We are still all in amazement two weeks later.
So how did they convince the markets that raising rates is really an un-hike? Partially with cleverly managing expectations and part with fundamentals. As far as expectations, the Fed was clear to forecast its expectation for three hikes this year when some were anticipating four hikes. The FOMC members also scaled back their longer-term target for unemployment to 4.7% from 4.8%, which allows them to be accommodating for longer, said they are looking for a sustained return to 2% inflation, and to cap off the dovishness there was even an unexpected dissenter, Minneapolis Fed President Kashkari. As far as fundamentals, the fed fund rate is still way too accommodating by most all measures, and perhaps the markets understand economic fundamentals are really good enough for some normalization of short-term rates.
The Fed may have mastered the short-end of the curve yet longer term rates are still mostly beyond their control. Since the Fed announcement on the 15th longer term rates have actually fell. So obviously, there are some cross currents in the rates markets. The one current pushing longer rates higher would be improving GDP growth as the OECD recently projected and reinforced with last Friday’s encouraging US durable goods economic print and a strong European purchasing managers index number.
However, it appears there are stronger currents keeping longer rates in check which include cyclically high debt levels across the US, lower productivity, the drag from demographic shifts, a strong dollar, reducing global trade and still very low rates in Europe and Japan. Finally, the markets do seem to be factoring lower expectations for growth as the administration’s pro-growth legislative agenda meets the realities of governing, as we saw last week.
The opportunity for more income in the front end of the curve and some price stability in the longer end is not a bad combination. Let the un-hikes continue!
Sources: Federal Reserve, Bloomberg, BCA