This week in markets will be all about the Federal Reserve.
On Tuesday and Wednesday, the Federal Open Market Committee (FOMC), which is the committee that sets monetary policy, will meet and the meeting will culminate with the Fed’s latest policy announcement at 2:00 p.m. ET on Wednesday.
According to market data from Bloomberg, markets think there is a 96% chance the Fed raises its benchmark interest rate to 0.75%-1% from 0.50%-0.75%, an increase of 25 basis points. Markets have assigned a 4% chance to the Fed hiking by a more aggressive 50 basis points. This would be the third rate hike since the financial crisis.
On Friday, we learned that in February the U.S. economy added 235,000 jobs as the unemployment rate fell to 4.7%. This was a bit better than markets had expected, and more or less solidified that a rate hike would happen this week.
“The February employment report all but confirmed the Fed‘s view that the US labor market is at or very close to full employment, giving them a bright green light to raise rates at the March meeting and continue its message of further normalization,” write Bank of America Merrill Lynch economists Joseph Song and Michelle Meyer.
The drama in this week’s Fed meeting, then, won’t be the rate hike itself but how the Fed tweaks its economic projections and the commentary from Fed Chair Janet Yellen during her press conference after the announcement.
“Given that the hike has been so strongly signaled, what will likely be more interesting is the fate of the Committee’s economic and interest rate forecast,” writes JP Morgan economist Michael Feroli. “There we anticipate that the median participant will look for four hikes in 2017, up from the three hikes projected in the most recent forecast round in December.”
Last week, you’ll recall that after markets had a March rate hike as about a 50-50 proposition, the odds spiked to a near certainty after hawkish commentary from New York Fed president Bill Dudley and Fed governor Lael Brainard. It isn’t, however, that any major economic data last week seemed to change the U.S. economic story of improving sentiment, improving labor markets, and seeming stalled-out top-line GDP growth.
“We, and consensus, expect a hike for the simple reason that the Committee has effectively told us they would,” Feroli writes. “It remains a mystery why they reached a tipping point last week and what pushed them past that point, but there is little mystery what the message was in the final communication before the blackout period.”
And so a rate hike it will be.
Hard data vs. soft data
Over the last couple months, an emerging theme in markets had been a divergence between “soft” and “hard” economic data. “Soft” data, or business and consumer surveys, has spiked and remained strong since the election. “Hard” data like retail sales, GDP, and the jobs report, has been operating on a lag.
Friday’s jobs number, however, indicate that this meme probably ought to die a quick death. “No one is talking about the hard vs. soft data trope today,” Neil Dutta, an economist at Renaissance Macro wrote Friday. “The data comes from thousands of firms and worksites throughout the country. Aggregate hours worked are up 3.1% annualized in the last three months.”
Yet another market narrative kicked to the curb.
Looking beyond the Fed implications of Friday’s jobs report, the rebound in wages — which rose 2.8% over the prior year in February, just below December’s 2.9% post-crisis high — shows that, Trump or not, the economic expansion and reflationary environment the global economy entered in the middle of 2016 continues to bloom.
“Ultimately, we believe the economic regime has materially shifted,” writes BlackRock’s Rick Rieder.
“And [Friday’s] data reinforces what we have argued for quite some time: that the economy is reflating and growing at a very nice, and durable, clip… Today, many economists and strategists are reacting to a Fed that can and will move at least three times this year (without exogenous shocks, in our view), but there is a pernicious argument that has entered into these debates, namely that the Fed is now tightening and creating restrictive policy. Nothing could be further from the truth.
“That is primarily because the elasticity of interest rate sensitivity is not linear and is in no way symmetric at different rate level thresholds. In other words, moving policy rates from 4% to 6% would essentially shift financial conditions from fairly restrictive to more restrictive, but moving rates at the lower end of the spectrum must be thought of differently. Indeed, moving from negative real rates to modestly positive rates is not only still extremely accommodative and economy/market supportive, but it brings the financial system closer to equilibrium.”
And in this, Rieder echoes comments we heard from Chair Yellen last week, who said in a speech in Chicago that 2014 was a “turning point, when the FOMC began to transition from providing increasing amounts of accommodation to gradually scaling it back.”
The conversation about Fed action in and around markets discussed the central bank raising rates. But with real — that is, inflation-adjusted — interest rates still negative, raising rates isn’t, as Rieder notes, tightening policy as it is removing accommodation.
And while this is more of a fine-tooth-comb-style look at the current economic situation, it is these kinds of differences that get us closer to understanding what the Fed is, or is not, thinking.
Economic calendar
Monday: Labor market conditions index, February (2.5 expected)
Tuesday: NFIB small business optimism, February (105.8 expected; 105.9 previously); Producer prices, February (+0.1% expected; +0.6% previously)
Wednesday: Empire State manufacturing, March (15 expected; 18.7 previously); Consumer price index, month-on-month, February (+0% expected: +0.6% previously); “Core” consumer prices, year-on-year, February (+2.2% expected; +2.3% previously); Retail sales, March (+0.1% expected; +0.4% previously); Homebuilder sentiment, March (65 expected; 65 previously); FOMC rate decision (0.75%-1% expected; -0.50%-0.75% previously)
Thursday: Housing starts, February (+1.2% expected; -2.6% previously); Building permits, February (-2.6% expected; +4.6% previously); Initial jobless claims (240,000 expected; 243,000 previously); Philly Fed manufacturing (30 expected; 43.3 previously); Job openings and labor turnover survey, January (5.5 million previously)
Friday: Industrial production, February (+0.2% expected; -0.3% previously); Capacity utilization, February (75.5% expected; 75.3% previously); University of Michigan consumer sentiment, March (97.0 expected; 96.3 previously)
Churn under the surface
Look at headline stock indexes since the election, and it seems like everything is going up.
And while the recent push to record highs has brought out the skeptics who believe we’re approaching something like a blow-off top amid unsustainable stock valuations, under the surface of these headline index pushes there has been quite a bit of churn. And pain.
Earlier this week on Yahoo Finance’s The Final Round, Joe Fahmy of Zor Capital, outlined that while the headline indexes seemed to go nowhere during 2015 and 2016, “underneath the surface was a brutal bear market.”
“Financials corrected 25%, biotech 40%, and energy 50%,” Fahmy said. “And if you look at just small- and mid-caps, they corrected between 25% and 30%, and the median stock was down over 20%. So individual stocks were down much greater than the indexes were masking.”
These comments echo what Michael Batnick, director of research at Ritholtz Wealth Management said at the Yahoo Finance All Markets Summit back in February.
On Thursday, Batnick noted on Twitter that the S&P 500 was just 1.6% off its recent high, but the average stock in the index was down nearly 10% from its 52-week high. The median stock was down about 6% from this high.
Additionally, Batnick noted that all ten of the index’s biggest components were within 3% of recent highs with the exception of Exxon. In other words, most of the pain was being felt my smaller companies.
And the small-cap Russell 2000 was down 2% this week and is off 3% this month. This month, in contrast, the S&P 500 is up 0.1% and this week the benchmark index lost just 0.4%.
The experience across stocks, then, has been far from uniform and this is particularly worth keeping in mind when breaking down what undergirds calls for this being not the end, but the beginning of a new secular bull market.
—
Myles Udland is a writer at Yahoo Finance. Follow him on Twitter @MylesUdland
Read more from Myles here: