- The Fed March minutes struck an unexpectedly dovish tone that supported equities and Treasuries
- We continue to think that the Fed will start raising rates at the middle of next year
- Greece returns to the bond market – economic fundamentals improve, debt sustainability still an issue
Fed´s March minutes strike an unexpectedly dovish tone
The minutes of the Fed´s March meeting were somewhat more dovish than expected. For a start, there was no evidence of an explicit discussion that policy rates could be raised six months after the ending of the Fed´s QE-programmes, something that was suggested by Chair Yellen in the press conference after the meeting. Although we do not know whether or how many FOMC members would support such a move, we continue to think that Ms. Yellen´s remark was no slip of the tongue. Meanwhile, the minutes showed that the FOMC met by videoconference to discuss the consequences of removing the 6.5% threshold. This was done because market expectations of the future course of monetary policy were seen as being ´reasonably well aligned´ with those of the Fed, and members were afraid that a change to a more qualitative forward guidance could ´disturb this alignment´. Again, the caution surrounding the scrapping of the 6.5% threshold suggests that FOMC members had no plans to signal to markets that earlier-than-expected rate hikes was something that could be on the table. Meanwhile, FOMC members also feared that the upward shift in participants´ projections of the federal funds rate in comparison to December´s Summary of Economic Projections could be misread as indicating a move by the Committee to a less accommodative reaction function. But ´several participants´ noted that the increase in the median projection ´overstated the shift in the projections´. Finally, concerns about the low level of inflation shined through the minutes. For example, five participants saw the risks to their inflation forecasts as tilted to the downside, while members generally agreed that ´in light of their concerns about the possible persistence of low inflation´, ´inflation developments should be monitored carefully for evidence that inflation was moving back toward the Committee´s longer-run objective´. The unexpectedly dovish tone of the minutes were welcomed by financial markets with equities and Treasuries rallying and the dollar coming under pressure. However, we continue to think that FOMC members understate the strength of the recovery. As such, we believe that the unemployment rate is set to fall faster than the Fed currently projects. In turn, this should eventually prompt the Fed to start raising rates at the middle of next year, with the federal funds rate rising to 1.5% at the end of 2015.
Greece returns to the bond markets
In a milestone for Europe’s sovereign debt crisis, Greece will return to the government bond market today for the first time since it was bailed out in 2010. The government plans to sell 5y bonds with a target amount of around EUR 2.5bn. Investor appetite for peripheral bonds has strengthened noticeably on the back of easing concerns about a euro break-up, helped by the ECB’s OMT programme and the clear commitment of European governments to the single currency area. In addition, fundamentals in peripheral countries are improving and economic growth is returning. At the same time, more positive risk sentiment and the low rate environment has encouraged a search for yield. Finally, speculation about a large scale ECB QE programme has also driven spread compression over recent weeks. Given recent investor euphoria and the fact that Greece is coming to the market in the first place, it seems likely that demand will be strong. We are positive on Greece’s economic outlook, but we continue to think that it has a debt sustainability problem that is not yet clearly resolved. On the positive side, Greece competitiveness in terms of relative unit labour costs has improved sharply and is now close to the levels seen at the start of the euro era. Economic growth is also now returning, and we thing that the Greek economy could be one of the positive surprises of 2015 (with growth of 3%). However, government debt is in excess of 170% GDP and some kind of ‘solution’ is necessary, which will likely involve restructuring of official sector/bilateral loans. Until a clear plan is in place to restore Greece’s debt sustainability, this will remain a cloud on the horizon.