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Here Comes The “4 Rate Hike” Bandwagon

Courtesy of ZeroHedge. View original post here.

Moments ago we reported that while Wall Street (if not market) consensus is clearly shifting to a hawkish view of 4 rate hikes this year in the aftermath of Powell’s hawkish testimony to the House, at least one strategist, SocGen’s Kit Juckes is not buying it, and wrote that “global level inflationary pressures aren’t noticeably building, fuels the view that the growth spurt at the end of 2017 is now behind us.

Whether it is the recent slide in the Atlanta Fed’s Q1 GDP estimate, or the various global economic surprise indexes…

… one could argue that Juckes is right.

And yet, a quick skim of the various market comments this morning shows that the SocGen analyst is clearly in the minority. As Bloomberg notes, the Powell session before the House, which many expected to be a ho-hum event that would have minimal impact on stocks, ended up spooking the markets thanks to comments that signaled an increased slant at the March meeting toward four rate hikes this year. Here are a few reactions of note, via BBG:

  • Evercore ISI vice chairman (and former New York Fed official) Krishna Guha: “Had thought the message in March would be 3+3 (three in 2018, three in 2019) with the Committee moving to 4+3 in June once the inflation data had firmed further. Following Powell’s remarks there seems to be a good chance that many or even most FOMC participants will go to 4+3 in March”
  • JPMorgan Chief U.S. Economist Michael Feroli (who remains in the four-rate-hike camp for both 2018 and 2019): “We now think the odds are tilted slightly in favor of the median participant revising up their outlook to look for four hikes this year and another three hikes next year”

And here is Wall Street’s thought leader, whose chief economist, Jan Hatzius, overnight wrote that:

We agree with the market’s hawkish assessment of Powell’s comments. At this point we see roughly even odds that the median dot will show 3 hikes (2.125%) or 4 hikes (2.375%) for 2018 in March, and we think the median dot for 2019 is likely to move up from 2.7% to 2.875%”

And for those curious what else Goldman – which last week suggested that there is even a probability of 5 rate hikes this year – said to justify its hawkish stance, here is the full note.

* * *

Powell’s First Testimony Hints at a Shift Up in the Dots

Jerome Powell made his first major appearance as the new Chairman of the Federal Reserve today in testimony before the House Financial Services Committee. Powell presented an upbeat take on the economy and noted that his outlook has improved incrementally since the FOMC’s December meeting, a comment that sparked a sell-off in the Treasury market and appeared to raise the odds of an upward move in the Fed’s dot plot at the March meeting.

Powell’s comments on the economic outlook were generally optimistic. He noted that several factors that were once headwinds for the economy—fiscal policy, foreign growth, and financial conditions—were now all tailwinds, the recent volatility in financial markets notwithstanding. Powell said that he expects the next couple of years to look “quite strong” with continued improvement in the labor market, inflation moving up to 2%, and faster wage growth. He also downplayed some concerns raised by members of Congress, noting that he was not bothered by the flattening in the yield curve, saw “at most modest risks” to financial stability, and did not see recession risk as “at all high at the moment.”

Powell also noted that his outlook has improved incrementally since the FOMC last submitted economic projections in December. Relative to expectations at the time, he noted, the larger-than-anticipated tax cuts and federal spending increases would boost demand further. That more stimulative fiscal policy, strong incoming economic data, strength in the labor market, encouraging inflation news, and continued strong global growth have caused his outlook for the economy to strengthen. Appearing to link this improved outlook to the March dot plot, Powell then noted that FOMC participants will be “taking into account everything that’s happened since December.”

The Treasury market sold off in response to those comments, as shown in Exhibit 1. Most investors appeared not to have anticipated that Powell would both acknowledge the incrementally better news and link it to the FOMC’s projections for its policy rate so soon and so straightforwardly.

Exhibit 1: The Bond Market Sold Off in Response to Powell’s Hawkish Comments

We agree with the market’s hawkish assessment of Powell’s comments. However, the implications for the March dots are more complex. While Powell’s comments raise the odds that he and other FOMC participants will shift their dots up in March, where the median dots will settle is less clear.

The end-2018 median dot is a very close call and at this point we see roughly even odds that it will show 3 hikes (2.125%) or four hikes (2.375%). Our interpretation of the December dots suggests that a shift from a three-hike to a four-hike baseline would require four participants to move up and for new Richmond Fed President Thomas Barkin to project at least four hikes in 2018 in his first submission. A recent comment from President Kaplan, shown in the table in the appendix, suggests that he is still at three hikes, meaning that four other participants would have to move up. We take Powell’s comments today to indicate that he is likely to move, and the decisions are likely correlated.

The end-2019 median dot is more likely to move up to 2.875%, from 2.7% in December. This would happen if one participant moved up or if the participant who projected 2.75% (the only participant who projected a point instead of a range in 2019) moved to 2.875%.

The end-2020 median dot appears likely to come in at 3.125%. A larger increase would require five participants to raise their terminal dot, which seems unlikely at this point. The longer-run dot also appears likely to remain stable at 2.75% in March, but could move up at some point later this year.

In addition to his comments on the economy and monetary policy, Powell also offered views on several financial regulatory issues in response to questions from members of Congress. At a high level, Powell emphasized that the Fed aims to strengthen the “primary pillars” of post-crisis financial regulation: risk-based capital requirements, liquidity requirements, the stress tests, and resolution planning. But he also expressed support for regulatory reform in several areas:

  • Supplementary leverage ratio (SLR). Powell said that the current calibration of the SLR is “not appropriate” because it “seems to be deterring some low-risk, wholesale-type activities that we really want financial institutions to engage in.” He added later that the Fed has the calibration “a little bit wrong” following its enhancement of the SLR and plans to “roll that back.”
  • Volcker rule. Powell expressed agreement with the argument that it might be worth giving greater discretion to bank trading desks so that they could intervene in illiquid and volatile markets. He also said that the Fed would be ready to take on the role of lead regulator in multiagency discussions as it takes a “fresh look” at the Volcker rule.
  • Stress testing. Powell said that the Fed could continue on the path of becoming more transparent and highlighted the stress tests in particular as an example.
  • Regulatory relief for small banks. Powell expressed support for tailoring regulation for small and community banks, which he said is “at the heart of what we’re doing at the moment.”

While Powell had expressed support for financial regulatory reform in the past, his comments today seemed to express a slightly firmer intention to make changes to the enhanced SLR and the Volcker rule.

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