Originally published by Rivkin Securities
Despite the slew of economic data on Tuesday investors were focused on Fed Chair Janet Yellen’s testimony before the Senate Banking panel. Striking a somewhat hawkish tone Yellen said “waiting too long to remove accommodation would be unwise” noting it may result in the FOMC having to raise rates at a quicker pace further on. Should inflation and employment continue to strengthen in line with expectations it would be “likely appropriate” to increase borrowing costs at the upcoming meetings. Keeping all options open for the timing of the first hike in 2017 in reference to the March, May and June meetings Yellen commented “I can’t tell you which meeting it would be”.
At this stage the case could be argued for the first rate hike in either March or June as comments from Federal Reserve officials seem to suggest the FOMC also remains split on the decision. There is a strong case for the FOMC to err on the side of caution waiting until June rather than March as policy makers assess the potential impacts of stimulus policies from Donald Trump. However if they intend to raise three times during 2017 at a gradual pace, gradual being the key word, then they need to begin shifting the market perception towards the March meeting.
In prepared remarks Yellen referring to market based measures of inflation noted that “they have risen from very low levels” in early 2016. The first chart below highlights one such measure, the five-year break even rate, which is measured by the difference between US treasuries and inflation protected treasuries. Since January 1st 2016 the five-year rate has risen 42 basis points to +1.956% as has the ten-year rate, up +46.8 basis points to +2.021%. Longer-term inflation expectations also seem to be well-anchored, which is very important from a monetary policy perspective. Inflation becomes a self-fulfilling prophecy, if you truly expect prices to be higher in the future you are more likely to spend today, all else being equal this increase in aggregate demand translates into higher prices.
Reacting to the more hawkish tone, the implied probability of a hike at the March meeting shifted upwards to 22.1% from 13.3% while the June meeting remained little changed at 46.2% from 47.1% the prior day. The US dollar index strengthened +0.28% in line with rising bond yields as both the two and ten-year treasury yields gained +3.6 basis points and +4.1 basis points respectively. Equity markets continued their march into new all-time highs with both the S&P500 and Nasdaq 100 up +0.29% & +0.14% respectively. The S&P 500 was led higher by financials (+0.91%) on the back of those rising yields while the more defensive sectors which underperform as rates rise lagged behind, with utilities and telecommunications down -0.74% & -0.27% respectively.
Locally the S&P/ASX 200 gave back early gains to finish relatively flat, down just -0.09% at 5,755.24. This morning we can expect another run at the key technical resistance level of 5,800 with ASX SPI200 futures up +27 points in overnight trading.
Data releases:
· Australian Westpac Consumer Confidence Index (MoM Feb) 10:30am AEDT
· Australian New Motor Vehicle Sales (MoM & YoY Jan) 11:30am AEDT
· U.K. Average Weekly Earnings & Unemployment Rate (3M/YoY Dec) 8:30pm AEDT
· Euro-zone Trade Balance (MoM Dec) 9:00pm AEDT
· U.S. CPI (MoM & YoY Jan) 12:30am AEDT
· U.S. Average Weekly & Hourly Earnings (YoY Jan) 12:30am AEDT
· Janet Yellen Testimony To House Panel 2:00am AEDT
Chart 1 – U.S. Breakeven Inflation Rates
Source: Rivkin, Thomson Reuters