- Fed’s post-meeting statement suggests that June rate hike remains very unlikely
- Unemployment claims remain in very favorable shape at decade-plus lows
- U.S. Q1 GDP expected to dip to a very poor +0.6%
- 7-year T-note auction to yield near 1.63%
Fed’s post-meeting statement suggests that June rate hike remains very unlikely — The stock market reacted favorably to yesterday’s post-meeting FOMC statement. The FOMC downgraded its assessment of global risks by saying that it is “closely monitoring” global economic and financial developments, dropping its previous statement that
“global economic and financial developments continue to post risks.” However, the FOMC again declined to provide a balance of risks assessment. While it is possible that the FOMC no longer intends to provide a balance of risks assessment as a communication tool, the more likely scenario is that the FOMC will signal that a rate hike is coming closer when it reinstates an assessment that the balance of risks are neutral or biased to the stronger side.
In any case, the federal funds futures yield curve fell slightly in response to yesterday’s FOMC meeting. The federal funds futures contracts on a yield basis fell by -1 bp for the Dec 2016 contract, -3 bp for the Dec 2017 contract, and -6 bp for the Dec 2018 contract.
The federal funds market is discounting only an 18% chance for a rate hike at the next FOMC meeting on June 14-15. However, we believe the odds for a rate hike at that meeting are closer to zero since that meeting comes only a week before the June 23 Brexit vote. The odds currently favor Britain voting to remain in the EU, but a surprise “exit” vote could tank the European markets and potentially cause systemic problems in the UK and Europe. The FOMC would look foolish if it raised interest rates on June 15 and then systemic risks emerged just a week later with a surprise Brexit vote to exit the EU.
After June, the odds for a rate hike will ramp up fairly quickly if the U.S. economy can recover from the weak Q1, if Europe gets through the Brexit vote without any systemic problems, and if China remains stable. We look for one Fed rate hike by year-end. The federal funds futures market is discounting the chances for a Fed rate hike at 36% by July, 58% by Sep, 82% by Nov, and 94% by Dec. The market is not discounting a 100% chance of a rate hike until Jan 2017.
Unemployment claims remain in very favorable shape at decade-plus lows — The initial unemployment claims series has dropped for the last three weeks straight and fell to a new 42-1/2 year low of 247,000 in last week’s report. Meanwhile, the continuing claims series last week fell to a new 15-1/2 year low. The extremely low level of unemployment claims shows that businesses are hanging on to their employees and are engaging in an extremely low number of layoffs. The market consensus for today’s report is for a +12,000 increase in initial claims (after last week’s -6,000 to 247,000) and an unchanged level of continuing claims (after last week’s -29,000 to 2.137 million).
U.S. Q1 GDP expected to dip to a very poor +0.6% — The market consensus for today’s Q1 GDP report is for a decline to +0.6% (q/q annualized) from the already-weak Q4 report of +1.4%. Q1 personal consumption is expected to sag to +1.7% from +2.4% in Q4 as consumers reduced their spending. The market consensus for Q1 GDP has progressively fallen to the current level of +0.6% from about +2.0% at the beginning of the quarter, illustrating the amount of disappointing economic data that has been released over the last three months.
The U.S. economy continues to be supported mainly by consumers since there is weakness in the other sectors of GDP, including business investment, net exports, government spending, and inventories. The U.S. economy still has a high level of inventories to work off, which means the GDP report will be hurt by a continued inventory correction. In Q4, personal consumption was the only sector contributing to GDP growth with a +1.66 point contribution. By contrast, business investment and government spending contributed a negligible +0.06 points and +0.02% points, respectively, while net exports subtracted -0.25 points and inventories subtracted -0.22 points.
The markets will partially shake off today’s expected weak Q1 report because of seasonal factors since GDP in Q1 has been weak in each of the past two years. Q1 GDP was -0.9% in 2014 and +0.6% in 2015. Recent studies have shown that the GDP seasonal adjustment factors are not working particularly well and that there has been some residual seasonal weakness in Q1. Yet there is no denying that the trend of GDP is down with GDP sagging from +2.0% in Q3 to +1.4% in Q4, and to an expected +0.6% in Q1. Nevertheless, the market consensus is for GDP to rebound higher to +1.8% in Q2 and Q3 and then to +2.1% in Q4.
7-year T-note auction to yield near 1.63% — The Treasury today will sell $28 billion of 7-year T-notes, concluding this week’s $103 billion T-note package. Today’s 7-year T-note issue was trading at 1.63% in when-issued trading late yesterday afternoon. That translates to an inflation-adjusted yield of a paltry 0.05% against the current 7-year inflation expectations rate of 1.58%.
The 12-auction averages for the 7-year are as follows: 2.47 bid cover ratio, $17 million in non-competitive bids to mostly retail investors, 4.2 bp tail to the median yield, 13.3 bp tail to the low yield, and 51% taken at the high yield. The 7-year is slightly above average in popularity among foreign investors and central banks. Indirect bidders, a proxy for foreign buyers, have taken an average of 56.1% of the last twelve 7-year T-note auctions, which is slightly above the average of 55.9% for all recent Treasury coupon auctions.
