FOMC Preview: Three things to watch out for this Wednesday – The Fed is widely expected to raise the target range for the federal funds rate by 25bp this Wednesday, to 1.50-1.75%. The focus for markets will be on: 1) the quarterly update to the Summary of Economic Projections (SEP), 2) the tone of Chair Powell at his first FOMC meeting press conference, and 3) the outside risk that the Fed announces a switch to press conferences after every meeting going forward.
For the SEP, we expect both growth and inflation forecasts to see upward revisions, with growth likely to see the biggest upgrades on the back of the fiscal boost from the Bipartisan Budget Act (current 2018 Fed forecast: 2.5%; ABN AMRO: 3.0%; 2019 Fed: 2.1%; ABN AMRO: 2.7%). The upgrade to inflation forecasts is likely to be more modest and mechanical (in the 0.1-0.2pp range), coming on the back of the stronger uptick in inflation we have seen in the first two months of the year, which was driven by factors we do not view to be sustainable.
We expect the median fed funds rate projection for 2019 to shift up to 2.9% from 2.7%, with 2018 unchanged. Expectations for a shift up in the dots have increased given a number of more centrist members on the committee have sounded somewhat hawkish of late (notably Dudley, Quarles, and Chair Powell himself). While we expect the median projection for 2019 to shift up to expecting a full six hikes between now and the end of that year (i.e. the median moves up from 2.7% to 2.9%), we think it will be on the borderline whether the median for 2018 shifts to four hikes. Although there are four potential switchers that could alter the median, there is uncertainty particularly over newly-appointed Thomas Barkin’s views, and this could be enough to tilt the balance. The futures market is currently 90-95% priced for three hikes in 2018, but the Bloomberg consensus is now at four hikes for this year. A shift up in the median FOMC projection to four hikes in 2018 would certainly have an impact on markets, but given the degree of expectation now for this to happen, we suspect the market reaction would be just as big if the median stayed at three hikes for this year.
In terms of Chair Powell, while his prepared statement is likely to be balanced, we expect he will continue to sound moderately hawkish in the Q&A in emphasizing the upside risks to growth, consistent with his congressional testimony performance a few weeks ago. We have seen some suggestion that he may use the opportunity of his first FOMC meeting as Fed Chair to announce that there would be a press conference after every FOMC meeting going forward, rather than once per quarter. The market would no doubt take this as a hawkish sign that the Fed could hike at a quicker-than-quarterly pace, as it has only hiked at press conference meetings thus far in this cycle. While we think such a move would indeed give the Fed more flexibility, another important element to the end-quarter meetings is the update to the SEP – arguably a key input into the policy decision-making process – and so we think the bias at the Fed would still be to take action at the end-quarter meetings rather than at the intra-quarter meetings. Ultimately, Fed policy depends primarily on the evolution of the data, not the frequency of press conferences. While inflation is recovering, the risk of it accelerating to such an extent that the Fed needs to hike more than four times this year is extremely low. As such, while the market would almost certainly react strongly in a knee-jerk fashion to the announcement of more press conferences, we do not think a move on this alone would be sustained. (Bill Diviney)
Non-Financial Credit: the primary market is back in action – EUR non-financial IG spreads were up by 5bp last week. Re-pricing was broad-based as it took place all across maturities as well as rating qualities. The reason for the slight correction seems to be mainly driven by new issuance, following the benign European inflation data and dovish statements from the ECB about the unwinding of quantitative easing. Indeed, issuers seem to have taken the positive market conditions as an opportunity to come to the market, as 20 out of the 30 deals that were priced so far in March were issued last week. Interesting to note is that a large chunk of last week’s deals were resulting from acquisitions announced in 2017 (such as Sanfo-Ablynx, SAP – Callidus, Vonovia-Buwog).
Furthermore, we have also noticed a change in the coupon type, as the share of floating rate deals more than doubled versus last year (31 vs 13 in 2017). What is more, these floating rate deals have also been the best performing. Another observation is that issuers have issued longer up the curve, as the average maturity of this year’s new issues stands at 9yrs, which is up from 6yrs during the same period in 2017. More importantly, the impact on the longer end of the credit curve remains limited, which is in line with our scenario. On average, spreads of the longer dated new deals widened by just 3bp more than the short-dated new prints. Improving economic conditions and strong guidance from the ECB on the purchase programme are largely credit to this. We expect that this should carry on for some time, leaving the door open for issuers to keep the primary tap running. (Shanawaz Bhimji)