This is certainly looking more and more likely, with the interest rate market increasing its implied probability of a lift in the fed funds rate from around 20% in early February to a 70% probability now.
Global economic data looking strong
There seems little doubt that economics are improving, and not just in the US, but also in Europe, the UK, Asia (including China) and Australia. Data has been beating analysts’ expectations and improving month-on-month, with a number of leading indicators suggesting that we are even seeing early signs of increased capital spending plans.
Throughout the economic recovery from 2009, the key component that was always missing was a pick-up in business investment. If this kicks into gear, then the mantra of ’animal spirits’ that both the Fed and Donald Trump have detailed will drive growth and inflation could feasibly come to life.
Of course, the real missing piece of the economic puzzle that would get everyone really excited is wage growth, which has been sorely missing in so many economies. But that could come if we do see investment married with a tight labour market.
Importantly, a number of key Fed members have acknowledged this improvement and there has been a noticeable hawkish shift from the Fed’s collective since the start of February. Just this week we heard from Philadelphia Fed president Patrick Harker, who stated that three hikes are appropriate this year. Fed president John Williams and Board of Governor (and known dove) Lael Brainard both suggested that a March hike is becoming a serious consideration.
Most notably though, New York president Bill Dudley, who is a core member of the Fed and has held a similar stance on monetary policy to Janet Yellen, told CNN International that the case for a rate hike had become ‘a lot more compelling’ and should happen ‘fairly soon’.
So economics have provided the Fed with the ammunition to lift rates again but, importantly, traders are actually seeing that as a positive sign. The fact the S&P 500, the Dow Jones, Russell and NASDAQ all keep hitting new highs despite markets pricing in a higher probability of tightening and a reasonable lift in all parts of the US fixed income curve speaks volumes.
It is clear that the market seems very comfortable with rate hikes, which is a very different phenomenon from two years ago, where even the mention of policy tightening would send the USD sharply higher and global equities (especially emerging markets) into a tailspin.
It seems this confidence is not just a reflection of Trump’s willpower and desire to provide a fiscal stimulus boost, but it comes at a time when global economics and company profitability are improving, while monetary policy is still accommodative.
The Trump factor
The Trump factor is also still very central to the markets’ euphoric rise, but we haven’t really heard much new from Trump. Trump’s speech to Congress on Tuesday was elegantly described by HSBC strategist Janet Henry as ‘low on detail and high on patriotism’.
She went on to say investors are putting faith in the direction and momentum of the conversation on stimulus, but largely ignoring the execution and implementation risks, and I would strongly echo these thoughts. There are still many questions being asked about key aspects of the proposed border tax adjustment, how the US plans to balance the $1 trillion infrastructure proposal, and of course the level of opposition he faces in getting these measures passed through Congress.
We should also remember that a large number of Fed official have actually priced Trump’s fiscal stimulus into their calls for three rate hikes in 2017. So if these plans don’t live up to expectations, then equities and the USD will face headwinds.
For now though, the USD basket is making a renewed bid to push through the 15 February highs of 10,169. A daily close through the level would undoubtedly be a bullish development and we can expect a test of the December highs here. So, for me, this market should be on everyone’s trading radar.
A March hike is looking increasingly likely, but it’s not a done deal. A decent US payrolls report on 11 March with wage growth above 2.7%% will likely seal the deal (consensus 174,000 jobs). It's worth keeping in mind that if we do hear from Bill Dudley’s fellow core Fed members Janet Yellen and Stanley Fischer this week, their comments could really give the USD rally further fuel.