It Takes Powell to Convince the Market that Yellen was Right

Many market participants think they heard Fed Chair Powell give a
fairly strong signal that he favored a more aggressive course.
implied yield on the December Eurodollar futures rose five basis points to
1.535%.  The December Fed funds futures contract rose three basis points.  

The market moved not to pricing in a fourth hike this year, but to fully
price in the third hike, which the December dot plots implied. 
third hike would bring the effective Fed funds rate to 2.17% and the implied
yield of the January 2019 Fed funds futures contract is 2.155%. It took
Powell’s apparent comfort with a more aggressive path to convince the market of
something the Fed’s dot plot indicated more than two months ago. 

We do not think that Powell will be pleased with the market’s reaction. 
It seemed to misconstrue. He prefaced his comment by saying he did not want to
prejudge the FOMC, but that his personal outlook for the economy had
strengthened.  This is important.   What strengthened? 
Powell’s outlook.  What does that mean?  We think it means that he is
more confident that the Fed is on course to reach its mandated

We continue to believe that the superior strategy here is not to change the dot
plot to four hikes this year. 
The anti-inflation credibility of the Powell Fed
will already be bolstered by a hike at his first meeting as Chair.  The
Fed need not signal its intention to hike more aggressively.  By the June
FOMC meeting, the trajectory of prices and the economy will be clearer. 

Ironically, a couple of hours before Powell testified, data were reported
that prompted economists to revise down Q1 18 GDP forecasts.
the recent softness in housing starts into account as well, the Atlanta
Fed GDPNow tracker lowered its estimate to 2.6% down from 3.2% on February
16.  It began the month near 5.4%.  It is the lowest estimate in four

To be sure, it is not just in the US that the synchronized global
recovery has met the New Year. 
Surveys and sentiment indicators in
the euro area warn that economic momentum may have peaked.  One exception
to a string of mostly softer than expected reports was the February German
employment data released today.  Unemployment fell more than expected,
with the unemployment queues shrinking by 22k instead of the 22k the median in
the Bloomberg survey expected.   Unemployment fell by an average of almost
16k a month in 2017.   The three-month average now stands at a
-25.3k, the most since April 2011. 

Price pressures remain steady.  Today the preliminary estimate of
February CPI was reported at 1.2%, in line with expectations, down from 1.3% in
January.  Last February headline eurozone inflation reached 2.0%. 
The core rate was steady at 1.0%.  It was steady at 0.9% throughout Q4 17,
which is also where it was in February 2017.  Progress?  

The Japanese economy practically stagnated in the last three months of
  It has begun the new year on weak footing.  Consider
January retail sales.  The 1.8% drop in the month was three-times more
than expected and is worth six-month of sales at the average monthly gain
in 2017 (0.3%).   Industrial output slumped 6.6% in January.  It
is the largest decline since 2011.  The market had expected around a 4%
fall after December’s 2.9% gain. 

China disappointed as well.  The official February PMI readings
were weaker than expected.  The manufacturing PMI eased to 50.3 from 51.3
and new export orders fell for the second month in a row.  Factory
employment declined for a fourth month (48.1).  The non-manufacturing PMI
slipped to 54.4 from 55.3.    The result is a composite reading of
52.9 (from 54.6) which is below last year’s lows.  Small businesses were
especially weak and this warns of downside risk to the Caixin PMI due out on
Thursday in China.  While it is tempting to dismiss the weakness due to
the Lunar New Year, we suggest the holiday exaggerated some trends that are
already in place.   

Just as China announced it was sending a high placed economic adviser for
President Xi to the United States, the US Commerce Department charged Chinese
aluminum foil makers with getting unfair subsidies and dumping their product in
the US. 
This is separate from the pending decision on aluminum and
steel on national security grounds.  The Commerce Department wants to
charge duties for both the dumping and to offset the unfair subsidies. 
The US imported about $390 mln of aluminum foil in 2016 from China, according
to reports.  In an unusual step, it was
the government that reportedly led this charge rather than industry, though
domestic producers have complained about Chinese competition. 

The US will likely report a small downward revision in Q4 17 GDP (2.5%
from 2.6%), largely because consumption was slower than initially
Still, the report is too historical to matter much. 
The Chicago PMI for February is expected to be consistent with the early
February data of an economy steady at elevated levels.  However, given the
losses in the US stock market yesterday, it may be the main focus today for
other markets. 

The S&P 500 recorded an outside day yesterday, trading on both sides
of the previous day’s range, and finishing below the low recorded then.
In addition, it closed below the gap created by Monday’s higher opening. 
It held the 50% retracement (~2743.45) of the gains from last week’s
highs.  Below there is the five-day moving average near 2735.3 and the
next retracement target is near 2732.7.  A break of these levels suggests
a test on more important support in the 2697-2700 area.   A slightly
higher opening is currently expected.   

While Asian shares took the US slide hard, European bourses are only
marginally lower. 
The MSCI Asia Pacific Index was off 1%.  It is
the biggest decline in three weeks.  Europe’s Dow Jones Stoxx 600 is off
0.2%, a sliver more than yesterday.  

Ten-year benchmark yields are around a single basis point lower today,
while US 10-year yields are stead just below 2.9%. 
Japan’s 10-year
yield settle a basis point higher, though very long-end of the curve held in
better after the BOJ reduced the amount of bonds 25-years and longer than it
would but to JPY70 bln from JPY80 bln.  The BOJ has cautioned against
reading policy signals in the fewer bonds being purchased.  The Yield
Curve Control policy and the smaller float means the BOJ can buy few bonds to
implement its strategy.  Nevertheless, the yen strengthened on the news.

The US dollar is mostly steady to firmer.  The Canadian and
Australian dollars join the yen in resisting the dollar’s pull.  Of note,
the Australian dollar, which has lost its interest rate advantage over the US,
has found support at its 200-day moving average (~$0.7785).  The Aussie
has only marred this moving average since moving back above it a little before
Christmas.  The US dollar closed decisively above its 200-day moving
average against the Canadian dollar yesterday for the first time since last

Today, for the first time since mid-December, the US dollar is also
rising above its 200-day moving average against the Swedish krona.
That average today is found a just below SEK8.25.  Softer than expected
inflation data earlier this month go the ball rolling.  Today’s data
showed softer than expected, though still solid Q4 17 GDP (0.9% rather than
1.0%) and softer January retail sales (0.1% vs. 0.4% expected).  

Sterling is at the lower end of yesterday’s ranges.  The market
is awaiting political theater later today when the EC releases its draft Brexit
proposal, which apparently ignores some of UK’s positions, which May be
expected to reject in a much-anticipated speech on Friday.  The euro
extended yesterday’s losses.  A convincing break of $1.2200 is needed to
signal the next leg down for the euro.  If it holds, short-term
participants may conclude it is the bottom end of the new range. 


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