From BlackRock: Chief Investment Officer of Global Fixed Income Rick Rieder shares three reasons why a March Fed rate increase is a possibility.
Fed funds futures pricing recently implied a roughly 25% likelihood that the Federal Reserve (Fed) will raise interest rates at its March meeting. We believe, however, the odds are probably closer to 50%. Though our base case is that the Fed may not raise rates next month, a March hike is still very much on the table. Philadelphia Fed President Patrick Harker noted earlier this week that “March should be considered as a potential for another 25 basis point increase.” Markets may not be adequately pricing this in, underestimating the chance that the Fed may act in March, in our view.
Here’s a quick look at three reasons not to write off a March hike.
The Fed’s dual mandate is nearly met.
The Fed is very close to achieving both its mandated goals—“maximum employment” and “stable prices.” After a modestly soft fourth quarter, labor market growth displayed greater strength in January. Nonfarm payroll growth came in at 227,000 jobs, considerably better than the consensus expectation of 175,000 jobs. And while the unemployment rate ticked up slightly last month to 4.78%, it has been hovering around NAIRU levels in recent months. We expect continued labor market strength will allow the unemployment rate to march toward the low-4% region by year-end as well as put upward pressure on wages. Meanwhile, both the headline and core consumer price index numbers are close to 2%, the Fed’s stated inflation goal.
The U.S. economy is likely to experience a growth pickup this year as reflation takes hold.
Goods-producing sectors of the economy have turned a corner. They appear to be emerging from a long-term recession into positive growth territory, and we expect this manufacturing recovery to be a key driver of stronger U.S. growth in 2017.
Fascinatingly, this goods-sector recovery, alongside the possibility of U.S. fiscal policy being back in play after several years of stagnation, is boosting confidence in a dramatic fashion. Both consumer and business confidence levels have improved remarkably across the board as the U.S.-led reflation environment has taken shape over the past several months. See the chart below. Typically, we might tend to place less weight on survey data of this kind, as aggregate opinion can change rapidly and in unexpected ways, but the pervasiveness of this optimism is striking. We expect it to translate into greater spending in the year ahead at both household and corporate levels.
Changes to the Fed’s policy statement.
The Federal Open Market Committee’s statement last week clearly reflected these improved economic conditions, as witnessed in the language changes in the first paragraph. Specifically, the statement noted that “economic activity has continued to expand at a moderate pace… Job gains remained solid and the unemployment rate stayed near its recent low.” Further, the committee highlighted that “measures of consumer and business sentiment have improved of late.”
The implications of this economic backdrop for monetary policy aren’t fully priced into markets, we believe. Market participants have anticipated some of the price momentum of the reflationary impulse, but they have been slower to accept the policy adjustment that reflation implies.
We believe the reflationary environment that has taken hold in the economy is likely to result in a moderately faster pace of rate normalization than what many expect. Assuming we continue to see strong data in the U.S. and avoid any unexpected market and economic shocks, another hike could come as early as next month. Indeed, we’ve long been saying the economy is ready for rate normalization. If the Fed does move in March, we most likely will see at least three hikes this year, as long as economic data remain supportive.
The iShares Barclays 20+ Yr Treas.Bond ETF (NASDAQ:TLT) fell $0.16 (-0.13%) in premarket trading Friday. Year-to-date, TLT has gained 1.43%, versus a 3.16% rise in the benchmark S&P 500 index during the same period.
This article is brought to you courtesy of BlackRock.