FOMC Preview: Green light from the Employment Report – Rabobank

According to Philip Marey, Senior US Strategist at Rabobank, the latest US Employment Report will encourage the Fed to carry out its recent plan to hike in March.

Key Quotes

“A strong nonfarm payroll growth figure of 235K, with an upward revision for January to 238K from 227K. What’s more, the unemployment rate fell back to 4.7% from 4.8%. Although there was a large increase in the labor supply, the employment growth measure in the household survey was even larger. Overall, a strong Employment Report. Note the sharp contrast with early June 2016 when the Employment Report for May showed that nonfarm payroll growth had plunged to 38K and derailed the Fed’s plan to hike in mid-June. This means that next week’s rate hike is a done deal, unless we see some major political or market event occurring.”

“The FOMC meets on March 14 and 15, and concludes with a press conference by Yellen.”

“Banking on confidence

• The Fed’s urge to hike only three months after the December hike, being very hesitant only a month ago at a meeting that revealed a lot of uncertainty regarding the fiscal policy plans of the new administration and its impact on the economy, suggests that the Fed is now making the same bet on fiscal policy as the markets. This suggests that the ‘animal spirits’ that are boosting the markets have reached the Fed as well. New York Fed President Dudley’s interview with CNN on February 28 showed this most clearly. He said that the large increases in household and business confidence, and very buoyant financial markets, had made them even more confident that the economy will continue to follow the trajectory projected by the FOMC.
• However, despite the upbeat confidence indices, the nowcast for Q1 GDP growth – published by the Atlanta Fed – has fallen to 1.2% as of March 8. This underlines how much the Fed is banking on the upbeat confidence indices and exuberant financial markets, setting itself up for disappointment sooner or later. If we are right in our assessment that the market rally is overdone and that it will be difficult for President Trump to deliver on his promises, then the Fed joining the party could make the bubble even more dangerous, ending in an even larger reversal.”

“Expectations beyond March

• In response to the Fed’s coordinated effort to raise market expectations we also adjusted our forecasts last week by adding a March rate hike to our outlook for 2017, which until then consisted of a single hike in December. Although we note an upward risk to our new baseline of an additional hike in June or September, we still have our doubts about the Fed’s plans to hike 3 times this year. After all, any kind of negative event could stop the Fed in its tracks and slow down the hiking cycle. In the first place, the timing, size or impact of the much vaunted fiscal policy plans could disappoint. In the second place, protectionist policy measures (including a possible border adjustment in the new tax plan) could cause trade conflicts that would also have a negative impact on the US economy and markets.
• In the third place, the global economy may have some negative surprises in store for the Fed, which appears to see less risk from overseas. Global growth is weak to begin with, and could be undermined further by protectionist tendencies around the world or adverse effects from rising USD interest rates. Meanwhile, China remains a downside risk to the global economy, and the same is true for developments in Europe. We still think that the probability of reaching the end of the year without an accident is smaller than 50%.”