- FOMC balance sheet reduction “later this year” and negative Ryan comments on tax reform help sink stocks
- Markets wait to see how the Trump administration will deal with China as the Trump-Xi summit arrives
- Unemployment claims remain in good shape
FOMC balance sheet reduction “later this year” and negative Ryan comments on tax reform help sink stocks — The minutes from the March 14-15 FOMC meeting, which were released on Wednesday, said that “a change in the Committee’s reinvestment policy would likely be appropriate later this year.” The minutes said that “the Committee would continue its deliberations on reinvestment policy during upcoming meetings.” The minutes said that participants agreed that a reinvestment policy change should be communicated to the public “well in advance of an actual change.”
The minutes said the FOMC is still considering whether to cease reinvestment all at once or just phase out reinvestment so that the balance sheet falls by only a certain amount each month. That choice makes a big difference because an abrupt end to reinvestment would mean the balance sheet would drop more quickly since the bulk of the Fed’s Treasury holdings expire within in the next 6 years. The markets would prefer a phased reinvestment policy change so that the Fed’s balance sheet decline is slower and smoother.
The minutes said that Fed participants agreed that the balance sheet reduction should involve both Treasury securities and agency MBS. There was no mention of NY Fed President Dudley’s recent comment that the Fed might halt its interest rate hikes temporarily when it starts reducing its balance sheet.
The minutes indicate that the Fed’s current plan is to raise interest rates two more time this year and in addition start reducing its balance sheet later this year. That is a rather hawkish plan, but the markets yesterday took the news in stride, partly because the markets give only 60% odds on the second rate hike by December. The fed funds curve after Wednesday’s FOMC minutes was little changed through mid-2018, but turned more dovish by -2 bp for late-2018 and by -4 bp for late-2019.
T-note prices lost a few ticks after the minutes were released but then more than recovered. The S&P 500 index, by contrast, fell by about -1% after the minutes were released in part because of the additional comment in the minutes that, “Some participants view equity prices as quite high relative to standard valuation measures.” That may have been a warning that the Fed will not back off on its tightening measures even if the stock market starts to correct sharply lower.
U.S. stocks were also hurt in the afternoon by House Speaker Ryan’s comment that the House and Senate were closer together on Obamacare repeal-and-replace than they were on tax reform, which was a reason why they chose to focus on health care first. That was not an encouraging sign that there will be any agreement soon on tax reform.
Markets wait to see how the Trump administration will deal with China as the Trump-Xi summit arrives — The markets are nervously awaiting the Thursday/Friday summit in Florida between President Trump and Chinese President Xi Jinping. The odds favor a stage-managed meeting with claims of a successful outcome on both sides. However, there is the possibility that U.S.-Chinese trade or security disputes could break out into the open and alarm the markets. The summit could also be disrupted by more North Korean missile tests or even a nuclear bomb test, as recently warned by South Korean intelligence.
The Trump administration is demanding that China address U.S. trade and currency complaints and also help curb North Korea. China, on the other hand, benefits from maintaining the status quo. The question is whether China will be helpful enough on trade and on North Korea at the summit to satisfy the Trump administration, or whether the Trump administration will feel that it must take some provocative actions against China to prove its seriousness.
If the Trump administration at the summit does not believe that China is willing to significantly step up its pressure on North Korea, for example, then the Trump administration as soon as next week may launch a new round of sanctions against North Korea that ensnares some Chinese banks and businesses that deal with North Korea. The Trump administration has already reportedly notified China about these potential new sanctions.
The U.S. might also announce new efforts to help South Korea and Japan further improve their military capabilities to deal with the threat from North Korea, which would draw protests from China. On trade, there are any number of actions the Trump administration could take to get China’s attention.
In the bigger picture, the markets are waiting to see if the Trump administration and China will be able to manage their differences over the next four years, or whether the relationship devolves into tit-for-tat retaliatory measures or something even worse such as a trade war or military confrontations in the South China Sea. The stakes are very high for the markets on U.S.-Chinese relations.
Unemployment claims remain in good shape — U.S. businesses continue to hold on to their employees and engage in the lowest level of layoffs in decades, providing another illustration of the tight U.S. labor market. Initial unemployment claims are only +31,000 above the 44-year low of 227,000 posted in late-Feb. Meanwhile, continuing claims are +65,000 above the 17-year low of 1.987 million posted in the previous week. The consensus for today’s report is for initial claims to fall by -8,000 to 250,000, adding to last week’s -3,000 decline to 258,000. The consensus is for continuing claims to fall by -22,000 to 2.030 million, reversing part of last week’s +65,000 rise to 2.052 million.
