- Odds for Fed tightening rise substantially on strong US retail sales and CPI reports and Yellen testimony
- U.S. unemployment claims remain in good shape
- U.S. housing starts expected to hold December’s gain
Odds for Fed tightening rise substantially on strong US retail sales and CPI reports and Yellen testimony — The markets on Tuesday and Wednesday substantially raised the odds for Fed rate hikes. The federal funds futures market is now discounting a 44% chance of a rate hike at the FOMC’s next meeting on March 14-15, up from just 30% on Monday. The odds of a rate hike by the following meeting on May 2-3 are about 75%.
If the Fed raises interest rates at either of its next two meetings as is now much more likely, then it will have plenty of time to raise interest rates twice more before the end of the year, thus meeting the “Fed dot” projection for three rate hikes this year.
The markets on Wednesday tightened up the federal funds futures curve by 4-6 bp, adding to Tuesday’s 3-5 bp move. Wednesday’s move in the federal funds rate curve was mainly due to the strong U.S. retail sales and CPI reports. Jan retail sales (ex-autos) rose sharply by +0.8% m/m, indicating that U.S. consumers are making good on the recent surge in confidence with a spending spree.
Meanwhile, the Jan CPI report was stronger than expected and that fueled increased inflation expectations. The Jan CPI rose to +2.5% y/y from Dec’s +2.1%. and the core CPI rose to +2.3% y/y from Dec’s +2.2%. The 10-year breakeven inflation expectations rate rose by +5 bp in the past two sessions to 2.06%, which is just 3 bp below the 2-1/2 year high of 2.09% posted on Jan 19.
Fed Chair Yellen at her Congressional testimony on Tue/Wed contributed to increased market expectations for Fed rate hikes because she stressed that the Fed’s inflation and labor market goals are “very close” to being met and she also suggested that the Fed could proceed with rate hikes even if the exact outlines of the Republican fiscal agenda are not yet known.
The markets are still expecting a less than 50-50 chance for a rate hike in four weeks on March 14-15. However, a 44% chance of a rate hike at that meeting is high enough to take seriously, particularly if expectations for rate hikes continue to rise over the next few weeks. That could happen if the near-term U.S. economic and inflation data strengthens or if Republicans start to make significant progress on their fiscal agenda.
U.S. unemployment claims remain in good shape — The U.S. unemployment claims series remain in good shape with U.S. layoffs near the lowest levels in more than a decade. The initial claims series last week fell by -12,000 to 234,000, which was only +1,000 above the 43-3/4 year low of 233,000 posted in November 2016. Meanwhile, the continuing claims series is only +95,000 above the 16-3/4 year low of 1.983 million posted in November 2016.
The market consensus for today’s report is for an +11,000 rise in initial claims to 245,000, reversing most of last week’s -12,000 decline to 234,000. The consensus is for continuing claims to fall -23,000 to 2.055 million, more than reversing last week’s +15,000 rise to 2.078 million.
The low level of layoffs is just one aspect of the generally strong U.S. labor market. Payroll growth has averaged +183,000 over the last six months, indicating steady job hiring even though U.S. businesses have already hired 15.6 million new people since the trough of the Great Recession. The Jan unemployment rate of 4.8% was up by +0.2 points from the 9-1/2 year low of 4.6% posted in November, but was right at the Fed’s estimate of the long-term steady-state level. There are still weak pockets of the U.S. labor market involving discouraged workers and the long-term unemployed, but those are not problems that can be easily addressed with the blunt tool of monetary policy.
U.S. housing starts expected to hold December’s gain — The market is expecting today’s Jan housing starts report to be unchanged at 1.226 million, holding steady after December’s surge of +11.3%. Housing starts have been very volatile in the past several months (Sep -9.6%, Oct +23.0%, Nov -16.5%, Dec +11.3%). However, the series remains generally strong considering that the December level of 1.226 million units was only -7.1% below the 9-1/3 year high of 1.320 million units posted in Oct 2016.
Housing starts should remain generally strong in 2017 since demand for new homes remains strong, supplies are tight, and prices are high. Home builder confidence remains strong as seen by the fact that the NAHB housing index in February of 65 was only 5 points below the 11-1/2 year high of 70 posted in December.
However, the markets will continue to assess the negative impact that will be seen from the post-election surge in mortgage rates. The current 30-year mortgage rate of 4.17% is up by +63 bp from the pre-election level of 3.54%. Still, mortgage rates remain at very low levels from a historical perspective and most potential home-buyers probably realize that mortgage rates are likely to move higher over the next few years as the Fed raises interest rates, meaning that now is still a good time to buy a home.
