FOMC leaves policy unchanged but expected 2018 rate hike reaches new high
ISM manufacturing index expected to remain just below the recent 13-1/2 year high
Unemployment claims expected to remain favorable
Vehicle sales expected to ease to trend level as the hurricane spike dissipates
Eurozone inflation statistics are stable but inflation expectations are rising
FOMC leaves policy unchanged but expected 2018 rate hike reaches new high — The outcome of the Tue/Wed FOMC meeting was in line with market expectations and the stock and bond markets showed little reaction. However, the federal funds futures curve tightened by 2-3 bp for the 2019-2020 contracts. In fact, the market is now expecting 67.5 bp worth of rate hikes in 2018, which is the largest 2018 rate hike expected yet.
The market is now expecting nearly 2-3/4 rate hikes in 2018, much more than the two rate hikes that were expected as recently as mid-December. Rate-hike expectations have risen since mid-December because of Congressional passage of the tax-cut bill and the rally in crude oil prices to a new 3-year high, both of which have boosted inflation expectations and put increased pressure on the Fed to raise interest rates.
Meanwhile, the rise in expectations for Fed tightening and higher inflation have put upward pressure on T-note yields. Indeed, the 10-year T-note yield on Wednesday reached a new 3-3/4 year high of 2.75% but then fell back to close the day -1.5 bp at 2.71%. The 10-year T-note yield has risen by more than 30 bp since mid-December when it became clear that Congress would pass the tax-cut bill.
The T-note and T-bond market on Wednesday also had to absorb the negative news that the Treasury boosted the size of next week’s 10-year and 30-year auctions by $1 billion to help fund this year’s larger U.S. budget deficit.
Looking ahead, the market is discounting the odds at 100% for a +25 bp rate hike to 1.25-1.50% at the next FOMC meeting on March 20-21. That will be the first FOMC meeting presided over by Jerome Powell, who becomes the new Fed Chair this Saturday (Feb 3) and will be sworn in on Monday (Feb 5). Mr. Powell will hold a press conference after the next FOMC meeting on March 20-21 and the FOMC will issue updated macroeconomic and interest rate forecasts.
ISM manufacturing index expected to remain just below the recent 13-1/2 year high — The market consensus is for today’s Jan ISM manufacturing index to show a -0.7 point decline to 58.6, reversing part of December’s +1.1 point increase to 59.3. Even if the ISM index today shows the expected -0.7 point decline, the index will still be in strong territory at 58.6. December’s index level of 59.3 was only -0.9 points below the 13-1/2 year high of 60.2 posted in Sep 2017.
The mood in the manufacturing sector has improved significantly since it became clear in December that Congress would approve big tax cuts. In addition to freeing up corporate cash, the bill also allowed the full expensing of capital equipment for the next five years. Other positive factors supporting the U.S. manufacturing sector include the weak dollar and strong overseas economic growth, both of which should help boost U.S. manufacturing exports.
The ISM new orders sub-index was even stronger in January, rising by +3.5 points to a 14-year high of 67.4. The strong orders index shows that the orders pipeline is very full, which is a strong leading indicator for manufacturing production and shipments.
Unemployment claims expected to remain favorable — Layoffs remain near the lowest levels in more than four decades, illustrating the strength of the U.S. labor market where businesses are holding on tightly to their employees. The initial claims series is only +17,000 above the 45-year low of 216,000 posted in mid-January and the continuing claims series is only +69,000 above its 44-year low of 1.868 million posted in early-Nov.
Meanwhile, there was good news on the hiring front on Wednesday after the ADP reported that January jobs rose by +234,000, substantially stronger than the consensus of +180,000. The ADP report has shown job gains above +200,000 for the last four reporting months. The strong ADP report boosted optimism ahead of Friday’s Jan payroll report, which is expected to improve to +180,000 from the weak Dec report of +148,000.
Vehicle sales expected to ease to trend level as the hurricane spike dissipates — The market consensus is for today’s Jan total vehicle sales report to ease to 17.25 million units from December’s 17.76 million pace. Vehicle sales spiked up to a 12-year high of 18.47 million units in Sep 2017 due to the need to replace vehicles after the major hurricanes in Florida and particularly Texas. However, vehicle sales have since seen been cooling off and are expected to ease in January to roughly match the 12-month trend average of 17.26 million units.
Eurozone inflation statistics are stable but inflation expectations are rising — Wednesday’s Eurozone Jan CPI fell by -0.1 point to 1.3% y/y, which was a bit stronger than market expectations for a -0.2 point decline to 1.2%. However, the Jan core CPI showed the expected +0.1 point rise to 1.0% y/y. Both the headline CPI of +1.3% and the core CPI of +1.0% remain well below the ECB’s inflation target of just under +2.0%.
While the core CPI has shown no sign of breaking out from its 4-year sideways range of 0.6-1.2%, market-based inflation expectations have in fact been rising. Notably, the German 10-year breakeven inflation expectations rate has risen sharply by +35 bp since mid-2017 and is currently at 1.31%, just mildly below the 1-year high of 1.34% posted in mid-Jan. European inflation expectations have been rising due to the strong Eurozone economy and rising crude oil prices.