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  • FOMC meeting minutes may indicate some hawkish sentiments
  • U.S. trade deficit expected to hit record high

FOMC meeting minutes may indicate some hawkish sentiments
 — The FOMC today will release the minutes from its March 16-17 meeting.  The outcome of that meeting was slightly dovish for the markets because Fed Chair Powell, in his post-meeting press conference, took pains to stress that the Fed continues to pursue a highly accommodative monetary policy. 

Mr. Powell repeated his comment that now is “not the time to start talking about tapering bond buying.”  He repeated his recent statement that he would only worry about higher yields if the rise was “disorderly,” but he went no farther than his previous comments.

The markets reacted positively to the outcome of that FOMC meeting.  The 2-year T-note yield fell by 2 bp on the results, although the 10-year T-note yield showed little reaction.  The S&P 500 index rallied by about +0.6% after the FOMC results and closed the day mildly higher by +0.29%.

Regarding the Fed’s dot-plot, Mr. Powell said, “The strong bulk of the committee is not showing a rate increase during the forecast period” through 2023.  However, the new dot-plot showed that there are now 4 FOMC members who are expecting a rate hike in 2022, up from one member in the December dot-plot.  For 2023, there are now 7 members predicting higher rates, up from 5 members in the December dot-plot forecast.  Moreover, 2 of those 7 members are very hawkish for 2023 and are predicting a +100 bp rate hike, while 3 of the members expect a +75 bp rate hike.

Comments from those more hawkish FOMC members could cause the minutes to be a bit less positive than expected. 

The Eurodollar futures curve shows that the market is now expecting the Fed’s first rate hike by late 2022 or early 2023.  The market is expecting an overall 100 bp rate hike over the next 2-1/2 years and an overall 250 bp rate hike by 2028.

Market participants this year have substantially boosted their expectations for Fed rate hikes due to the availability of effective vaccines and the expected end of the pandemic by late this year or early 2022.  Expectations for Fed rate hikes have also been boosted by the massive $5 trillion of fiscal stimulus that has been passed in the past year.

The consensus is for torrid U.S. economic growth in Q2 and Q3 of +7.0% and +6.9%, respectively.  For calendar year 2021, the consensus is for annual GDP growth of +5.8%, which would more than overcome the -3.5% decline seen in 2020.  The market is then expecting GDP growth to remain strong at +4.0% in 2022 before easing to the more normal level of +2.4% in 2023.

Since the end of 2020, the Eurodollar futures curve has turned more hawkish by about 25 bp for the late-2022 contracts and by 75 bp for the late-2023 contracts.  

Meanwhile, the 10-year T-note yield this year has risen sharply by +75 bp to 1.66% from the 0.91% level seen at the end of 2020.  The 10-year T-note reached a 14-month high of 1.77% last Tuesday, but has since backed off to 1.66%.

The 10-year T-note yield has eased a bit since last week due to the recent rise in the Covid infection rates, which illustrates that the pandemic is dragging on.  Also, the 10-year breakeven inflation expectations rate on Tuesday fell to a new 1-1/2 week low and closed -4 bp at 2.32%, down from last Wednesday’s 7-3/4 year high of 2.38%.

The stock market has recently become less worried about rising interest rates.  The S&P 500 index has rallied sharply in the past week and edged to a new record high yesterday regardless of the interest rate outlook.  The stock market is now looking on the brighter side of higher interest rates, i.e., that the rise in interest rates is being caused by expectations for the full recovery of the U.S. economy, which in turn would be very bullish for corporate profits.

U.S. trade deficit expected to hit record high — The consensus is for today’s Feb trade deficit to worsen to -$70.5 billion from -$68.2 billion in January.  

Today’s expected trade deficit of -$70.5 billion would exceed November’s deficit of -$69.97 billion and be the widest deficit figure since the trade series began in 1992.

The pandemic has caused the U.S. trade deficit to surge because U.S. exports have taken a much bigger hit than imports.  U.S. exports during the worst of the pandemic last spring plunged by -33%.  Exports have been weak relative to imports mainly because the U.S. economy has out-performed its trade partners due to the massive amount of U.S. fiscal stimulus.  In January, exports were still down by -7.6% y/y whereas imports were up +3.2% y/y.

The near-record U.S. trade deficit is a bearish underlying factor for the dollar since about $2.1 billion worth of U.S. trade dollars are pouring out of the U.S. every day.  Those dollars are mostly being sold back into the FX market by trade recipients who do not want to hold dollar-denominated investments.

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