Markets indicating thought change at the Fed?

Week ending Friday January 19 2018

Yields rising across the curve is undoubtedly a good sign.  The chances of a March rate rise have consistently risen, as well as further hikes in June and a final one in the fourth quarter some time. The two year yield curve has also risen above 2% but does not yet indicate any rate rises in 2019.

This rising short term rate environment has for the first time in a long while been matched by longer term yields. The 10 year yield is now above 2.5% for the first time since before the 2014 taper tantrum.

During 2017 rising short term rate expectations flattened the yield curve. Now the curve has the same steepness, or rather flatness, but at higher levels. In normal healthy (ie 5%) nominal growth environments the curve is usually flat at around 5%.

All this is happening without any signs of rising inflation, breakeven inflation rates have risen but to only just above 2%, so no worries at all on that front.

These bond market moves indicate that policy rate moves don’t matter, unless they indicate the Fed is acting against the market’s view of the state of the nominal economy. If they are going with the flow then no-one notices what they do – and that is good.

Is the NGDP targeting noise postively affecting markets?

The number of senior monetary experts discussing NGDP targeting in a positive way will not have gone unnoticed by markets, especially at a time of regime change at the Fed when new thinking is possible.

The USD stayed weak but is still only at the bottom of its trading range over the last three years. Relative strength in other currencies could explain the USD weakness but seem unconvincing. Sure, there is some new realism in the UK over Brexit but that hasn’t strengthened the GBP against the EUR. The ECB is thought to be discussing tightening policy, but still way in the future. We are watching this situation closely, especially the Draghi succession question. Japan has done little to indicate it will change its easy money stance, but the JPY has strengthened vs the USD too. Sometimes the currency market waters are very muddy.

Our 2019Q1 NGDP Forecast is still looking relatively robust at just over 4% growth YoY. A good reading in the 2nd estimate for 2017Q4 NGDI (due in February) will boost it further.

Data

Industrial Production and its subset Manufacturing Production have now climbed back to near normal growth rates, but these need to be exceeded for some time to allow ground to be made up for all the lost” production of the last several years. It is possible the normal (i.e. low) growth rates seen 2000-07 and 2010-14 will never be exceeded, perhaps because they are no longer a good guide to growth overall. Structural change may well be so great that old, conventional, industrial and manufacturing data just can’t capture the change in the tech or services sector.

The growth rate of corporate revenues is healthy and growing healthier. Factset reports 2017 will show a 6.2% growth rate in revenues, a level to be almost matched by the 5.7% rate forecast for 2018.  As usual, healthy revenue growth leads to better margins and thus an even faster rate of growth in earnings.

The one survey last week that cast a small shadow was the UMich Consumer Index showing both current conditions and expectations taking tumbles in January. Perhaps this pessimistic note came from the bad weather, perhaps the prospect of a government shutdown, or perhaps it was just noise. Markets ignored it.

Next week will see a number of private sector surveys for January, but government data releases must be in doubt given the shutdown just being entered. This is a bit of disappointment as we are scheduled to get the release of 2017Q4 GDP on Friday.

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