FOMC is likely to boost the Fed-dot forecast for rate hikes
President Trump reportedly doubles Chinese tariff package to $60 billion, inviting Chinese retaliation
U.S. stocks fall sharply on tech, tariffs, and Fed
FOMC is likely to boost the Fed-dot forecast for rate hikes — Fed Chair Powell will hold his first press conference tomorrow at the conclusion of the 2-day meeting. Mr. Powell’s comments in recent weeks suggest that he will be more forthright and blunt in its public comments than previous Fed chairs, suggesting that the markets may show bigger reactions to the post-meeting press conference than in recent years.
The markets are discounting the odds at 100% for a +25 bp rate hike this week to a new funds rate target of 1.50%/1.75%, according to the federal funds futures market. The Fed last raised its funds rate target three months ago at its December 12-13 meeting. The FOMC at its last meeting on Jan 30-31 left interest rates unchanged.
Since a rate hike tomorrow is considered to be a done deal, the markets are mainly focused on the extent to which FOMC members are likely to raise their forecasts for the funds rate over the next several years. There is plenty of room for the markets to react bearishly to this week’s FOMC meeting because the market is still undershooting the Fed-dot forecasts.
The median of the Fed-dot forecasts currently indicate FOMC expectations for +72 bp worth of rate hikes in 2018 (essentially three rate hikes), +56 bp of rate hikes in 2019 (2.2 rate hikes), and +37 bp of rate hikes in 2020 (1.5 rate hikes).
Market expectations for Fed rate hikes are close to the Fed dots for 2018, but the market is expecting less tightening than the Fed dots in 2019-2020. Specifically, for 2019, the market is discounting 42 bp of rate hikes in 2019, which is 14 bp less than the Fed-dot forecast of 56 bp. For 2020, the market is discounting only 5 bp of rate hikes, which is 32 bp less than the Fed-dot forecast of 37 bp.
The markets will also be watching to see if the FOMC might revise higher its “longer-term” forecast for the funds rate, which is essentially the Fed’s estimate of the natural rate of interest that is neutral for the economy. The FOMC is currently pegging its “longer-term” fed funds forecast at 2.75%, even though the FOMC is expecting the funds rate to rise as high as 3.00% by the end of 2020 before later falling back to 2.75%. The Fed’s current “longer-term” federal funds rate estimate of 2.75% is only +75 bp above the Fed’s 2.0% inflation target, which implies the Fed expects a longer-term real federal funds rate of only about 0.75%. Since 1971, the real federal funds rate target has averaged a much higher 1.79%.
President Trump reportedly doubles Chinese tariff package to $60 billion, inviting Chinese retaliation — After the U.S. markets closed on Monday, the Washington Post reported that the Trump administration now plans a tariff package totaling $60 billion per year on Chinese imports in retaliation for Chinese IP violations. That is double the $30 billion amount that USTR Lighthizer originally suggested last week, according to Politico. Politico last week said that President Trump told USTR Lighthizer to go back to the drawing board and come up with a larger package.
The Washington Post said that President Trump plans to announce the tariff package this Friday. The article warns that President Trump in the meantime could change his mind on the amount of the tariffs or the timing of the announcement. The U.S. trade deficit with China totaled a record $380 billion in the latest 12-month period (thru Jan 2018).
The original $30 billion size of the tariff package was designed to roughly match the estimated damages from Chinese IP violations. If Mr. Trump doubles the package so that is clearly exceeds claimed damages, then the Chinese government will be under increased pressure to retaliate. The Chinese government is already under pressure to retaliate for the Trump steel-aluminum tariffs.
The Chinese tariff news comes at an inopportune time since the markets are already on edge as President Trump’s steel and aluminum tariffs take effect this Friday at midnight. The markets are waiting to see what nations may be exempted from the steel-aluminum tariffs other than Canada and Mexico. If Europe doesn’t get an exemption, then the markets can expect Europe to go ahead with its threat to retaliate with tariffs on $3.5 billion worth of U.S. imports. Friday could turn out to be a doubly-bad day on trade if Europe is not exempted from steel-aluminum tariffs and President Trump also goes ahead with an announcement of a $60 billion tariff package on China.
U.S. stocks fall sharply on tech, tariffs, and Fed — The S&P 500 index on Monday closed the day sharply lower by -1.42% after being down by as much as -2.1% on the day’s 2-week low. The Nymex NYFANG+ index showed an even larger daily decline of -2.9%. Bearish factors included (1) a variety of bad news for the tech sector, (2) concern that FOMC members at their 2-day meeting that begins today will raise their Fed-dot forecast for the funds rate over the next several years, and (3) Trump tariff concerns.
Tech stocks saw a variety of bad news that included (1) news that Europe is considering imposing a 3% tax on revenue of large U.S.-based tech companies, (2) Monday’s -6.8% plunge in Facebook on news that Cambridge Analytica may have improperly used the profiles of some 50 million Facebook users, which could bring increased government regulation down on the entire tech sector, and (3) news that Uber halted its self-driving vehicle fleet after a self-driving vehicle hit and killed a pedestrian, which could attract increased government regulation to vehicle and delivery companies focused on self-driving technologies.