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March 22, 2018

BECAUSE: The way to get good ideas is to go through LOTS of ideas, and throw out the bad ones…

21 March 2018

Federal Reserve Commentary Wed 3/21/2018 3:58 PM

March FOMC Recap Stephen Stanley Chief Economist

The FOMC did just about exactly what I thought they would… Wed 3/21/2018 10:54 AM

February Existing Home Sales Stephen Stanley Chief Economist

… Despite a widely-repeated (and puzzling) mantra in the media that the housing sector is currently soft, anecdotal reports from builders and realtors across the country point to red-hot markets in most of the country. Builders continue to be plagued by cost increases (for both labor and materials) and labor shortages, and the weather in much of the country has delayed builders looking to get kickstarted in time for the spring selling season. Realtors point to very strong demand in cities with growing economies. In Denver, the market is “insane,” as anything below $1 million gets multiple offers and sells above list. Houston, southern California, and the Gulf Coast of Florida are sizzling, while the Boston and suburban New Jersey markets are “merely” solid. In many expensive markets, entry-level homes are snapped up above list, while there is a glut of high-end properties. Early signs of overbuilding are beginning to emerge in Miami condos and in the Dallas area, but most everywhere else, there are not enough properties available for sale to satisfy demand. The rise in mortgage rates are not pricing significant numbers of prospective buyers out of the market, but they are encouraging many to act fast, ahead of further hikes in borrowing costs. In all, reports suggest that buyers will snap up as much product as builders are able to punch out, but the basic story, tight inventories, rising prices, may remain in place for the foreseeable future.

March FOMC: Gradual normalization strikes a “middle ground” As we anticipated, the Fed hiked its policy rate and steepened the policy rate path in response to an improved economic outlook. While the median funds rate for 2018 remained unchanged at three hikes, the median member projected a higher path for 2019 and 2020. In addition, the average funds rate rose by 2030bp across the projection horizon. Both outcomes were broadly in line with our expectation. Surprisingly, the median estimate of r* rose modestly, although this was offset, to some degree, by a lower median NAIRU estimate. In our view, the Fed accomplished what it needed to today; namely, hiking rates and steepening its policy path without generating an unduly negative reaction in the financial markets. Although the Fed clearly sees fiscal stimulus as improving the outlook, the effects of the stimulus remain to be seen and anti-trade policies may be forthcoming. Chairman Powell was careful to say that the Fed had taken only one decision today – to raise the target range by 25bp – while further expected rate hikes embedded in the projections need to be supported by the data. We continue to expect a total of four 25bp rate hikes in 2018 and believe the Fed is likely to signal this in June when it has more evidence that fiscal stimulus is having its anticipated effect on the economy.

21 March 2018

March FOMC: A steeper policy path to balance risks of overheating against returning inflation to the Fed’s target As was widely expected, the Federal Reserve raised the target range for the federal funds rate by 25bp to 1.50-1.75% at its March meeting. Language around the outlook for economic activity in the FOMC statement plus the new set of economic projections suggest the committee’s outlook for the US economy has improved since it last met in January.

Economic activity rising “at a moderate rate.” No major adjustment to the language on inflation. Elsewhere in paragraph one, the committee, on balance, left its characterization of inflation unchanged. Committee’s outlook for the US economy has improved. .. A steeper policy path. The March projections contain a steeper policy path. Since the 25bp increase in the target range for the federal funds rate was widely expected, we see markets focusing primarily on what the bipartisan budget agreement will do for committee members’ expectations about the appropriate path for policy. Here, we expected committee members to balance a steeper policy path with the need to permit some of the fiscal stimulus to pass through and support a return of inflation to the Fed’s target. We expected the median funds rate to remain unchanged at three hikes in 2018, which was the case, and for an increase in the median funds rate in both 2019 and 2020. This was also the case, as the median member expects an average federal funds rate of 2.9% and 3.4% in 2019 and 2020, respectively, up from 2.7% and 3.1% previously. Even though the median funds rate for 2018 did not rise, the average funds rate did as seven members now expect more than three rate hikes this year versus four in December. The average funds rate rose about 20bp in 2018 and 2019 and by 30bp in 2020, a touch higher than what we had anticipated for 2019-2020. The median funds rate for the long-run was also revised higher, by 2.9% from 2.8% previously, as against our expectation of no change.

21 March 2018

US Public Policy Common Questions: Chinese Tariffs, NAFTA, and the Mid-terms Investors are noticeably worried about the stream of policy from Washington, damage to the rules-based international trade system (eg, tariffs against China, the future of NAFTA), as well as other issues. We therefore look at policies that could affect the economy and markets. With high approval ratings within his party, Trump is transitioning to some of the more controversial portions of his campaign and is willing to trim the pro-growth policies for what he thinks will consolidate his GOP base ahead of the November 2018 mid-term elections.

21 March 2018

US existing home sales rebound strongly in February; Q1 GDP tracking up one-tenth at 1.8% …With regard to the impact on our Q1 GDP tracking, this morning’s report was stronger than we had expected and implies higher broker commissions in Q1 relative to what we had penciled in. As a result, we revised our residential investment tracking estimate higher, which boosted our Q1 GDP tracker by one-tenth to 1.8%, after rounding.

22 March 2018

China: PBoC continues to follow Fed with 5bp raise … The PBoC elaborated on its thinking in a press briefing In a statement released after today’s rate hike, the PBoC said that the small increase in the OMO rate is in line with market expectations and also a normal market response to the Fed hike overnight. The PBoC added that given that money market interest rates have stayed significantly above policy rates since last year, despite the interest rate differential being somewhat reduced recently, the 5bp hike will help to reduce the differential, improve the monetary policy transmission, and help to guide reasonable interest rate expectations. These will help to contain irrational financing behavior and help stabilize macro leverage ratios. 21 March 2018

The Global Inflation-Linked Monthly

It Might as Well Be Spring The flatness of the US breakeven curve remains in focus for investors; we remain in TIIJan19 shorts (energy hedged), maintain our 5y5y versus 10yfwd20y real rate steepener call to fade the flatness of the forward real rate curve and also present updated regression models for TIPS. In the euro area, we turn tactically bullish breakevens, recommending buying the DBREURi30 as a tactical position. In the UK, we expect long real yields

to be supported by a combination of increased DB pension protections and the government looking to reduce its fiscal exposure to inflation; we also recommend IL22-29 ASW curve steepeners.

March 21, 2018

Lyngen/Kohli BMO Close: J-Dove's Headfake …One thing struck us as notable within Powell’s press conference, which was his observation that there is ‘no sense’ inflation is about to accelerate. This was certainly consistent with a gradual pace of rate hikes – and from our perspective added further support to the notion that 2.75% 10-year yields will be more easily achieved than 3.00%. In being intellectually honest (as we aspire to), today contained the biggest risk that yields would spike on an assertive Fed, and the fact that the market closed well off the lows gives us a great deal of solace in our more constructive call. …On the subject of the dots, we were one dot from a change in median forecasts and markets were one dot away from a more significant tightening. At least six FOMC members shifted their forecasts higher for 2018. The main effect of telegraphing a fourth hike this year would have been to push yields much higher and it would have suggested to participants that there was at least some (small) probability of a fifth hike. It’s unlikely the Fed would imply such a move without being very certain of being able to hike at least four times. The fact that the curve responded very little to a mild bump in 2019 and a larger one in the longer-term highlights the notion that some of this was already priced in and that projections past 2019 are much more heavily discounted. Volumes on Wednesday were light ahead of the Fed meeting with cash trading at 71% of the 10day moving average.

Tactical Bias: …Let us not forget that Thursday will bring the Treasury Department’s announcement of next week’s auction sizes – as a theme we expect this to add flattening pressure.

We’re expecting to see the 2-year auction size increased and we have penciled a $2 bn addition to $30 bn. This is admittedly a consensus view, but mounting front-end supply is already leading to some indigestion and we anticipate that as the Fed’s balance sheet runoff accelerates there will be a further rationalization in the short-dated sector of the rates market. Next week’s auctions clearly won’t be limited to 2s; we also see $35 bn 5s and $29 bn 7s. This creates a gross issuance figure of $94 bn, with offsetting maturities totaling $66.3 bn. The net new cash needed to fund supply is a far less daunting $27.7 bn -- the upper-end of the range, but unlikely to cause a more material concession. We do have the 10-year TIPS auction – which is really the biggest event in the day ahead, and that’s saying something about how little substantive data we have for the next session. The reopening of the January issue should be well-received as we expect that the combination of solid flows with positive early year sentiment will carry the product for a bit longer. The additional tailwinds for TIPS include some signs that global economic growth remains strong and that there is a lower risk of extremely low inflation prints in the coming months. Where we depart from our positive sentiment on the sector is in the fundamentals. For one, while strong and positive, flows have a propensity to chase seasonal moves in TIPS and have been diminishing in the past month. We’ve noted before that when we don’t agree with the direction of flows, we stand aside to let them play out and won’t actively lean against investor interest. As a result, we’ve penciled in a strong auction despite what we consider very rich breakevens (2.10% at this time) and poor coreCPI fundamentals. 5y5y remains similarly lofty at 240 bp, though off the highs we saw in the giddy optimism of Jan of this year (when economic models were running very hot on Q1 GDP estimates). Real yields are certainly higher than they have been in the past as well, and while that could bring in some structural buyers of the product, we won’t be among them.

March forecasts are even more suggestive of the Fed inevitably engineering a recession to bring the unemployment rate back to sustainable levels.

21 Mar 2018

US FOMC: Hawkish drift The FOMC raised the fed funds rate by 25bp, as expected, at its March meeting. The Committee as whole became more hawkish, raising its growth and inflation forecasts and lowering it unemployment projections, leading it to revise up its projected rate path expectations. The FOMC marked up its GDP growth forecasts by a cumulative 0.5pp through 2019, along with lowering its unemployment rate forecasts and raising its inflation forecast to an above-target 2.1%. On its rate expectations, the 2018 median rate dot held at three hikes by the thinnest possible margin. More meaningful to us is that the average dot rose for all years, signifying that the Committee as a whole has lifted its rate path expectations. We continue to expect that the Fed will hike four times this year, with the three remaining hikes coming in June, September, and December.

With the median dot holding at three hikes for this year by the tiniest of margin, for us the balance of risk is clearly weighted towards the FOMC bringing forward its rate path expectations. This is especially so given that, despite the FOMC voicing increasing confidence in inflation moving up to target, we still think its inflation forecast for this year is too low: 0.4pp too low versus our expectations. While it is possible the recent moderation in demand persists, we think it is more likely domestic demand strengthens and prices continue to rise in the period preceding the June meeting, and that the FOMC will hike four times this year.

21 Mar 2018 18:16:05 ET

North America Rates Flash FOMC: Fed proposes, market disposes 

…Policy Implications The FOMC’s March meeting showed an upward shift in stance, with the Committee now expecting a bit more than one additional hike through 2020 than it did in December. In terms of timing, the Committee is virtually evenly split between three and four hikes for this year, with six participants at three and six at four (with the two doves favouring no further hikes from here in 2018 versus one dove arguing for five hikes in total in 2018 ultimately keeping the median at three hikes). We think the risks to this forward guidance are tilted towards more projected hikes rather than fewer, both given how we expect the economy to evolve in the near-term (continued strength and inflation picking up as tailwinds overcome headwinds) and that at the June meeting there will likely be an additional hawkish dot in the form of Marvin Goodfriend, whose nomination for Fed Governor passed the Senate Banking Committee but still needs to be confirmed by the Senate itself. The step-up in core inflation between now and then argues in the same direction. Additionally, the increase in the longer run rate with an unchanged target means that the assessment of r* (the real neutral rate) is moving up in the Committee’s estimation. Since the Committee left its longer run growth estimate unchanged, this suggests that it is “other factors” that are rising, which aligns with its “headwinds to tailwinds” assessment of the economy’s current state. Even with adjusting up the longer run rate, the current dot plot still has the median fed funds rate at neutral in 2019 and 50bp higher than the longer run neutral rate in 2020, in addition a nearly 0.9pp gap between its 2020 unemployment rate forecast and its longer run neutral rate. In other words, the FOMC’s

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Today’s FOMC projections with a 0.5% cumulative increase in median 2019-2020 dots, a 0.1% increase in the median long term dot, a 0.2% cumulative increase in core PCE, a 0.8% decrease in the unemployment rate and a 0.5% increase in the real GDP rate, in combination should have resulted in a selloff in rates. Indeed, this was only the second time since the Fed began publishing projections in 2012 that the long term dot actually moved up (the last time this happened was in Dec 2016). Yet, the rates market still rallied. Why is that? Capitulation of bearish positions initiated into the FOMC by unsteady hands and nervousness ahead of the Section 301 tariff announcements tomorrow may be partly in play, but does not fully explain the rally. In our view the bigger theme is that the Fed is now boxed in with its new projections and will face consistency issues going forward. The new SEP inflation projections are unachievable - we don’t see a credible path to an overshoot in core PCE in 2019 or 2020. Indeed, Powell sought to downplay the move higher in dots during the Q&A session. Additionally, if labor force participation increases and the unemployment rate doesn’t go as low as 3.6%, will the Fed still hike rates in a low inflation environment? Powell also admitted in the Q&A that the natural rate is likely to stay low (“longer run values like neutral rate of interest are pinned down by slow moving forces “). And yet, the projections imply a desire to move above the natural rate by next year. Cumulatively, these add up to lower long term rates in our view - the Fed is getting outright

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restrictive as the overall yield curve flattening trend attests. Tactically, our plan was to buy the dip after the FOMC if Treasuries cheapened as a result of higher dots (see US Rates Weekly: The dot plot thickens). With today’s rally, we have to shelve that plan for now and we will wait for better opportunities to initiate longs. In the near term, we think rates are likely to stay range bound and we hold on to our short gamma position (see Alert: North America Rates Trade Idea - Sell gamma on 10y tails)

21 Mar 2018 15:58:15 ET

US Economics Flash FOMC: Still three hikes in 2018, faster pace later 

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As we expected, the 2018 median “dot” stayed put indicating three rate hikes in 2018, but median dots for 2019, 2020 and the “long run” moved higher. This confirms our core view on Fed policy: rate hikes will remain gradual in 2018, but significant fiscal stimulus implies a hike cycle that is more likely to continue through 2019. An unchanged median 2018 dot, despite upwardly revised growth and inflation forecasts, together with Chair Powell’s emphasis that the Phillips curve relationship between low unemployment and higher inflation has weakened, increases our confidence that the Fed will hike just three times this year (two further hikes). More importantly, changes in dots and forecasts are consistent with the idea that 2018 hikes are close to fully priced, but the market is underpricing the risk of further hikes in 2019.

22 Mar 2018 02:47:02 ET

Global Economics View Macro Update: Warning Shots, But Goldilocks Lives for Now •

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Bottom-line — The global economic outlook remains benign: global growth is expected to rebound from a softer Q1, inflation and wage pressures remain subdued. Gradual Advanced Economy (AE) monetary policy tightening is still our baseline. However, downside risks have increased slightly, including of more trade protectionism, geopolitical tensions and rising (late-cycle) financial imbalances. Global growth takes a breather but remains robust . We expect global growth to rebound in the remainder of 2018 to around 3.7% pace from around 3% in Q1.

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We expect AE Inflation to slowly rise to 1.8% in 2018, but inflation and wage pressure remain subdued. AE monetary policy to tighten moderately but at very different speeds. We expect the Fed to normalize interest rates and its balance sheet in a steady manner, while the BoJ and ECB remain very cautious. What is coming next? — US Section 301 investigation, attempts to form an Italian (and Catalan) government.

US Rates at the Bell March 21st, 2018 Traders Tab: “Smooth Jay” Outweighs Dot Upgrade: The Press conference, Powell’s first, was markedly dovish. Likely in an attempt to offset dot-plot upgrades and firmer Statement rhetoric, Powell said that there is “no sense in the data we are on the cusp of' an inflation surge”, while the neutral rate of interest is ``still quite low.'' On the more idiosyncratic issues, he said that “trade policy has become a concern for businesses”, while he played down, to some extent the upward shift in the dots, noting that fiscal stimulus could have “supply side effects” as well, with higher investment helping drive productivity higher. 

Recap & Discussion:

USTs closed slightly richer and steeper (after setting fresh intraday highs and lows in the postStatement churn), while the ED$ strip steepened out to greens as the SEP dots remain unchanged for this year, higher further out (EDZ8-Z0 +6bp). The FOMC Statement was revised positively, suggesting some improved confidence in economic activity over the medium-term, while Powell’s first presser as chair went swimmingly, as he was careful to offset the hawkish upgrades in the longer-dated SEPs. The Q&A saw Powell almost exclusively highlighted dovish caveats, saying there is “no sense in the data we are on the cusp of' an inflation surge”, while the neutral rate of interest is ``still quite low.''

…Px-action-wise, it was a manic “V”-shaped kneejerk back to unchanged after an initial jolt lower (in-line with ED$ greens), with more than 100k TYs traded in the 10mins post-Statement. According to the desk, vols were largely directional and not that active at first, with the end result being a crumble lower on aggressive fast$ sales into the close (1m10y -5n, 2y2y -2n, 1y10y 1.5n). In cash space, it was the front-end performance that really stuck out (2s -4.75bp) post-presser, with a complete (technical) reversal of yesterday’s break to a cyclical yield high (2.35%). Our desk reported better buying into the close, with month-end extensions eyed in the long-end, while flatteners were being cut into the post-FOMC vacuum. In swaps, steepeners were the postpresser axe (2s10s and 5s10s) from mixed accounts, while fast$ was much more actively receiving into the close (as equities hit new lows). Summarily, with our long-held belief that Powell will seek to retain dovish optionality proving true today, we think this leaves the window open to our contrarian bias for a bullish “upset”, with lower core market rates a likely result of positioning, technical, and current macro imbalances. With policy risk now behind us, we think increased focus on de-synchronizing global growth, as well as the lack of global inflation momentum (German PPI inflation -30bps in FEB, and China PPI decelerate 60bps) may yet have some wood to chop as positioning in UST’s remains historically short and in flatteners with >20% of the large TY short base (of 50mln DV01) at risk of going offside after today’s reversal. (Full Report: http://citi.us/2poYwC1). 21 Mar 2018 11:23:08 ET

RPM Daily Shorts and Flatteners in Vogue 

In North America – Long cash (+1.1) / short futures (-3.3): Around $3m DV01 of shorts added (in the front end up-to 10y) but ongoing long liquidation further out as client take profits on recent

flattening. The front end short positioning is expected to remain resilient today (given large shorts / profits). However further out along curve, asymmetric (short) positioning and small PnL suggesting ongoing vulnerability (to lower yields) and further flattening pressure. 

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In Europe – Long cash (+1.1) / short futures (-0.3): On lighter flows $3m DV01 of new longs added as the market builds on cross-market outperformance. However positioning remains lighter (relative to the US) with long end flatteners still in place. In Equity / FX – S&P (+1.1) / EUR (+1.9) / Credit (2.8): The market continues to trim long equity positions with ETF investor warehousing large losses. Meanwhile short Dollar positioning has lightened up as investors closed out positioning

21 Mar 2018 17:19:34 ET

Equity Strategy Buybacks Inside Out 

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Many market observers estimate that S&P 500 constituents’ stock repurchases may soar to $800 billion or more in 2018, up from about $520 billion in 2017. Equity repurchases prevent share creep, for the most part, with relatively modest declines in outstanding stock. Financials have caught up to the IT sector on cash use to reduce share count. Our focus remains on serial share shrinkers or companies that reduce their share count every year and thereby show managements’ dedication to generate shareholder value. Episodic buybacks are less interesting to us versus companies that seem to have the excess cash flow and strategic desire to return cash regularly. We often consider dividends to be a longer term commitment, but sustained share shrinkage typically rewards investors via outperformance. Investors appear to be getting worried about higher interest rates capping the ability to borrow cheaply and to use those proceeds to buy back stock.

1. S&P 500 Buybacks

21 Mar 2018 15:21:15 ET

US EIA Petroleum Statistics US oil balances tighter on shortterm factors, while a range of bullish and bearish waves could be on the way

Mar 21, 2018 3:00:19 PM

Is the Housing Market Rolling Over? Posted by Brad McMillan, CFA, CAIA, MAI

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Even as oil prices have been trading in a narrow range over March, underlying fundamental factors are in flux, both on the bull and bear side. US crude inventories fell 2.6-m bbls to 428.3-m bbls after several weeks of builds as refinery runs rose another 0.4-m b/d w/w to reach 16.8-m b/d while crude imports dropped. US crude production rose 26-k b/d w/w to 10.407-m b/d, another new high. Cushing inventories rose 0.9-m bbls to 29.4-m bbls, a second week of builds after a long period of draws as unobserved net outflows continue to run lower. Total crude and product inventories, ex-NGLs, fell 5.8-m bbls to 1,722-m bbls. Gasoline inventories fell 1.7-m bbls to 243.1-m bbls as apparent demand and exports eased. Diesel inventories fell 2-m bbls to 131-m bbls as exports eased w/w.

21 Mar 2018 19:38:33 ET

Global Economic Outlook and Strategy

…End of the cycle? We can argue whether housing is at the end of the cycle—probably not. What looks very likely indeed, though, is that the industry is past its best days for this cycle and is starting to roll over. If that is the case, we can also expect consumer confidence to start to roll over, and consumer spending to do the same. While this certainly is not a sign of immediate trouble, it is one more wideranging indicator that economic conditions are indeed starting to change—and not for the better. As I said the other day, now is the time to start thinking of what could happen when things roll over for certain.

March 2018 

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We continue to expect global growth of 3.4%YY in 2018 and 2019 (at market exchange rates), relatively steady global and AE inflation, and moderate AE monetary tightening. Our global forecasts are mostly unchanged this month. We see small upside risks to our 2018 global growth, global inflation and monetary policy tightening forecasts, but downside risks have risen this month. The risk of a material escalation of trade tensions is increasing, after the US imposed tariffs on aluminum and steel imports on national security grounds and as it prepares actions to address Chinese intellectual property practices in its Section 301 investigation. Our Senior Global Political Analyst argues that geopolitical risks are changing, and on balance, rising as well, particularly in the Middle East.

21 March 2018

US Economics Comment: FOMC hikes rates, but inflation projections show dovish signs …Overall, the outcome of this meeting was

relatively neutral. The committee hiked rates and raised their rate projections as expected, but also showed an increasing openness to growth and inflation temporarily overshooting in the medium term. The pace of rate hikes does appear responsive to better data and fiscal stimulus, but it would likely take large and persistent upside surprises in inflation for the hiking cycle to accelerate significantly. We continue to expect four hikes in total this year, with the next three occurring at the June, September, and December meetings.

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Deutsche Bank 21 March 2018

Fed Notes - What we got from the March FOMC statement and press conference

risk neutral higher, as does convergence of near-term rates towards terminal. The phases of the risk neutral curve that we introduced last week offer a useful tool for assessing and trading the Fed cycle. The risk neutral curve is either bear flattening (Phase 1, the current phase) or bull steepening (Phase 2, once Fed is seen as having gone too far) nearly 80% of the time. More often than not, falling term premium is typical of Phase 1, and rising term premium of Phase 2. The curve may encounter occasional volatile adjustments steeper (when term premium rises), but the structural Phase 1 trade is a bear flattener.

Peter Hooper The post-meeting statement, the Committee’s forecasts and Chair Powell's inaugural press conference were close to our expectations, marking a shift in a hawkish direction relative to December, although perhaps slightly less so than we had anticipated given recent Fed rhetoric. We were looking for three things following today’s FOMC meeting: (1) would there be a shift in language around risks being “roughly balanced;” (2) would the median dot rise from three to four rate hikes this year with the terminal dot rising commensurately; and (3) would Chair Powell convey a more hawkish tone with respect to the risks of the economy overheating?

21 March 2018

Global Market Strategy - Seeing red and blue - trading (and hedging) term premium and risk neutral •

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The behavior of risk neutral and term premium are core to our framework for understanding risk asset performance. Understanding how these components are likely to evolve, but also how to trade them is critical. This week we explore tradable proxies for term premium and risk neutral. Term premium can be approximated as a weighted reds (1y1y)/ blues (3y1y) steepener – if longer dated rate expectations are elevated versus near-term expectations, term premium will be higher. Risk neutral can be approximated with blues (3y1y) overlaid with a scaled reds (1y1y)/blues (3y1y) flattener – higher expected terminal level of rates pushes

…In the most recent GMS we introduced the idea of phases of the yield curve, which we specifically related to the risk neutral curve. Phase 1 has risk neutral rising, but by less and less in forward space as the Fed hikes, while real term premium remains generally low. Phase 2 arrives after the market judges the Fed as having gone

too far, with the risk neutral curve bull steepening and the Fed following by cutting rates (albeit not quickly enough to stabilize risk neutral and risk assets). Phase 3 comes when risk neutral finally recovers with the curve bear steepening as the Fed has eased sufficiently and risk assets recover. The phases are informative from a macroeconomic perspective, as risk neutral curve flattening also matters in gauging recession risks – in our recession probability model, a flatter risk neutral curve is consistent with a rising probability of recession. Recession probabilities are low today, but likely to rise over the next year or so to above 25% on a 12m ahead basis.

rises. Eventually bull steepeners should be considered, but we think the structural move is flatter before sustained steepening can begin. Prepositioning for the eventual roll-over into Phase 2 would involve the use of knock-ins (i.e. front-end receivers or SPX downside that knock-in on frontend rates reaching a given level). We showed the distribution of S&P returns last week when recession probabilities rise above 25% is bimodal – another way to position for a rolling over from Phase 1 into Phase 2 is via selling S&P straddles to buy strangles. …Risks to consider hedging – changing (or easing) of inflation target

Considering these distinct “phases” of the risk neutral curve is hugely useful because of the sheer amount of time that the market spends in either Phase 1 or 2. Since 1961, the risk neutral curve has either bull steepened or bear flattened in nearly 80% of quarters – bear steepening and bull flattening “regimes” are likely to be transitory and/ or transitional between the two more common phases (e.g. the stabilization phase after Phase 2, which we termed Phase 3, wherein risk neutral begins to recover when the Fed has eased enough and risk neutral finally recovers alongside risk assets). During phases 1 and 2, term premium does indeed tend to follow a better defined pattern, falling about 60% of “Phase 1” (risk neutral bear flattening) quarters and rising about that frequently during “Phase 2” (risk neutral bull steepening) quarters. Given the typical term premium performance during these different phases, it should not come as a surprise that the actual yield curve tends to co-move with the risk neutral curve, flattening 86% of the time during Phase 1 and steepening 84% of the time during Phase 2.

…Once the market recognizes the Fed has gone too far, Phase 1 gives way to Phase 2, with risk neutral falling and the risk neutral curve steepening as real term premium

Thus far we have only considered hedges for term premium and risk neutral in a simple nominal approach to risk assets and recessions. However, investors will recall that we have highlighted the importance of real and breakeven components of term premium and risk neutral rates in prior publications. We noted that breakeven term premium and risk neutral rates tend to be more stable than their real counterparts over the available history. Breakeven risk neutral is positively correlated with real risk neutral, and notably less volatile – nominal risk neutral being good for risk in part reflects the dominance of real risk neutral. Breakeven term premium is negatively correlated with real risk neutral and real term premium, which fits the story of higher real risk neutral is good for risk (breakeven term premium falls, but the coincidence of rising risk neutral helps to bail out risk assets). That nominal term premium higher is to the detriment of risk assets reflects the higher volatility of real term premium and negative correlation between real and breakeven term premium.

22 March 2018

Early Morning Reid Macro Strategy …As for new Fed Chair Jerome Powell, well in golfing terms it felt like he struck it straight down the middle of the fairway. That’s to say that he largely gave away an impression of one of continuity under his new role as Chair, and an emphasis still on the Fed sticking with its gradual approach to tightening. In other words, he didn’t appear like he was willing to deviate off

the well beaten path and into the rough. Indeed, his tone was fairly balanced while he sought to down play the importance of the median dot plots as well as adding “there is no sense in the data that we’re on the cusp of an acceleration in inflation”. Overall, DB’s Peter Hooper noted that the FOMC statement and Powell’s inaugural press conference were close to his expectations, marking a shift in a hawkish direction relative to December, although perhaps slightly less so than he had anticipated given recent Fed rhetoric. More specifically, he thought Powell’s debut performance was strong and highlighted that the Committee is likely going to need to see evidence that wage and price inflation are picking up meaningfully before becoming concerned about significant overheating associated with the tightening labour market. For more details, refer to Peter’s note.

projections released today provide more guidance on how the Fed expects both economic growth and monetary policy to develop in the years ahead. …What is most notable from the projections is that the Fed expects both inflation and the Federal Funds rate to overshoot the long-term targets in 2020, with inflation forecast to exceed the 2% objective at 2.1%, while the federal funds rate is forecast at 3.4%, a full 50 basis points above the 2.9% that the Fed believes appropriate over the long term.

21 March 2018 | 3:33PM EDT

March 21, 2018

Powell Takes Charge

In his first meeting as Chair of the Federal Reserve, Jerome Powell and company delivered what almost everyone had been expecting, a 25 basis point hike in the federal funds rate, and raised expectations for economic activity in the months and years ahead. While the hike (which we expect is the first of four in 2018) needs little more than passing mention given its essentially shoe-in status heading in to today's meeting, the Fed Statement and projection materials warrant closer inspection. …On the inflation front, the Fed took a more hawkish tone, changing their expectations for inflation to move to the Fed's 2% objective "in coming months", up from "this year" as was used in the January statement. With inflation closing in on the Fed's target and unemployment already low, the summary of economic

USA: FOMC Hikes Rates and Projects Modest Inflation Overshoot BOTTOM LINE: The FOMC raised the funds rate target range, as widely expected. The median dots in the Summary of Economic Projections remained unchanged in 2018 but now imply a third hike in 2019 and two hikes in 2020. Changes to the post-meeting statement were mixed. While the description of current economic activity was downgraded from “solid” to “moderate,” the committee added the sentence “The economic outlook has strengthened in recent months.” The economic projections were slightly more hawkish than we expected, with a 0.5% boost to the median level of 2020 GDP, lower unemployment in 2018-2020, and—for the first time— a modest core inflation overshoot in 2019-2020. While the post-2018 dots rose significantly, Chairman Powell emphasized the data dependence of policy. We continue to expect rate hikes to proceed at a quarterly pace this year and the next.

21 March 2018 | 10:55PM EDT

US Daily: FOMC Roundup: Moving Higher with the Data (Hill/Hatzius) 

There was something for everyone in today’s FOMC meeting. On the dovish side, the committee downgraded the near-term growth assessment and narrowly kept to a three-hike median for 2018. On the hawkish side, the

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committee noted an improved outlook, significantly upgraded its growth and employment forecasts, projected an inflation overshoot in 2019-2020, and steepened its post-2018 funds rate path by more than we and probably most others had expected. When all was said and done, the market took the meeting outcome as slightly dovish, with bond yields and the dollar both lower on the day. However, our main takeaway is that the committee’s views are evolving in line with the data and financial conditions, and its projections are now showing a meaningful overshoot of the dual mandate as well as a terminal funds rate that is in line with our own 3¼%-3½% forecast. We expect the next rate hike to come in June with subjective odds of 80%, and our baseline forecast remains four hikes in 2018 and another four hikes in 2019.

21 March 2018 | 7:01AM EDT

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21 March 2018 | 7:31PM EDT

Commodity Insights: Commodities are still the best hedge against rising inflation risks 

US Daily: The Next Shots in the Trade War (Phillips/Taylor) 

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Tariffs on imports from China look likely to be announced by Friday, March 23. However, the tariffs might take longer to implement than the recent steel and aluminum tariffs and the process could stretch out over several weeks. It is also possible that some aspects of the announcement that we have been expecting, such as the restrictions on Chinese corporate investment in the US, could be announced only in concept. It is unclear what products might be targeted, but the overall amount looks likely to be in the range of $60bn in imports, according to press reports. We note that unlike the steel and aluminum tariffs, which were 25% and 10%, respectively, the affected categories of imports from China are likely to face a much higher level of tariffs, potentially approaching 100%. We believe retaliation is likely, and note that in some recent cases China has announced its own protective actions within days of a US action but usually covering a fraction of the value of products targeted by the US. With China-focused investment and visa restrictions still on the horizon, it is possible that the announcement of those measures several weeks from now could prompt a further counterresponse from China. This delay could also lead to additional negotiations, which might reduce the likelihood that those restrictions will be applied. More generally, we expect that trade policy risks might soon reach a near-term peak. While NAFTA renegotiation remains a risk and adverse headlines

are a clear possibility, a US withdrawal from NAFTA looks unlikely. There are additional trade remedy cases in the pipeline in the US, but these cover only a few billion in imports in total and are in line with similar cases considered by other administrations We also note that the economic cycle, not the political cycle, has tended to drive trade restrictions in the US. Taking the solar panel, steel, aluminum, and forthcoming China-focused announcements together, the Administration will likely have announced tariffs covering at least $100bn in goods at a time that the jobless rate is at 4.1%. Either the Trump Administration is acting differently from prior administrations—clearly a possibility—or we should expect even more substantial trade restrictions when the unemployment rate eventually begins to rise.

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During most of the post-crisis recovery, inflation risks have been subdued. However, concerns with “overheating” and higher inflation are now being raised given a combination of strong global growth and diminishing economic slack, increasing labor market tightness, expansionary fiscal policy vs. only gradual normalization of monetary policy in the US, risks from trade protectionism / retaliation, and the potential for higher commodity spot prices as inventories continue to draw down. From the investor’s point of view, particularly those with a medium to long term horizon, the question directly shifts to how these inflation risks can be managed. We take this opportunity to re-examine our previous work on the abilities of various asset classes to hedge inflation. More specifically, we focus on short-to-medium term hedging abilities for both headline and core inflation (CPI excluding food and energy) and, in particular, ask “Are commodities still a good inflation hedge?” We think the answer is still a definitive “yes” for headline inflation. Hedging core inflation remains challenging regardless of the asset class used. However, we find evidence that commodities now act as a better hedge of core inflation than at any time in the past. This result is due to the substantial reduction in core inflation volatility since the widespread adoption of central bank inflation targeting, making “pass-through” effects from changes in energy

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prices to core goods prices more important over time. Finally, we find evidence that in periods of high price volatility, the hedging performance of commodities rises much higher than our previous estimates. For example, our previous average oil vs. inflation beta estimates of 15 – 20, suggests a portfolio allocation of 6.6% 5.0% to energy commodities. However, if we are more concerned with periods of high inflation volatility, then our beta estimates get closer to 30 - 40, which suggests an optimal allocation of only 3.3% - 2.5% to energy commodities. In other words, we find that commodities provide more hedging ability when it matters most, and do this using a smaller share of the portfolio than we previously estimated.

21 March 2018 | 11:39AM EDT

USA: Existing Home Sales Rebound in February

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consequence of its public sector purchase programme (PSPP) would reduce excess central bank liquidity. But such issuance is likely to require creation of some ‘off balance sheet’ vehicle running parallel to the ECB. As we have argued in our earlier analysis, it is unclear whether there is demand in the private sector for the mezzanine and junior tranches of SBBS that would be created out of the medium- and low-credit-quality sovereign bonds held on the ECB's balance sheet. As a result, SBBS issuance backed by the ECB's sovereign bond portfolio will not entail a transfer of fiscal risk back to the market. Keeping peripheral fiscal risk safely warehoused on central bank balance sheets will help to sustain the current relatively benign sovereign market environment. Yet (as a result) the issuance of SBBS backed by ECB sovereign debt holdings will have done nothing to address the politically sensitive issue of how much, in what form and for how long the ECB should continue to bear such fiscal risks.

Exhibit 1: The substantial excess liquidity in the Euro area is essentially backed by the ECB's purchases of sovereign bonds EUR billion

BOTTOM LINE: Existing home sales rose more than expected in February, driven by a rebound in singlefamily home sales. While today’s report suggested a firmer pace of residential investment in the first quarter, our Q1 GDP tracking estimate remained unchanged after rounding at +1.8% (qoq ar). Our March estimate for our Current Activity Indicator edged up by one tenth to 4.3%. 21 March 2018 | 1:01PM CET

European Economics Daily: The ECB, excess liquidity, fiscal risks and the SBBS 

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Although far from imminent, the ECB will eventually need to consider whether and, if so, how to reabsorb the excess central bank liquidity it has created via its asset purchase programmes. Excess liquidity is currently around EUR2trn. As we discussed in a recent European Economics Analyst, the European Systemic Risk Board (ESRB) has published a feasibility report on sovereign bondbacked securities (SBBS). While not the main objective of such an initiative, issuance of SBBS is one mechanism that may support the ECB in absorbing excess liquidity. Contrary to other possible tools (such as the issuance of ECB debt certificates), SBBS do not involve explicit crossborder risk sharing. SBBS may therefore offer a more politically viable approach. The issuance of SBBS backed by the portfolio of ECB sovereign bond holdings accumulated as a

March 21, 2018

JEF Economics

FOMC: Hikes Rates! 3 Hikes in 2018 & 2019, Economy “Strengthened” …The overall tone of the statement and SEP suggests that more FOMC policymakers are incorporating fiscal stimulus into growth and labor market expectations, but are still somewhat sensitive to the possible ramifications of the ongoing policy normalization transition…

Changes to Fed’s Summary of Economic Projections Policy Expectations: The Fed “dots” (the appropriate path of policy tightening) reflect a modest shift higher across the forecast horizon. They continue to reflect an expectation for 3 rate hikes in 2018 despite a sizable increase in the average projection for the year (it looks like the median would have risen if 1 additional forecaster shifted to the 2.375% camp). There was also an increase in the long-run forecasts.

Powell Presser… What Did We Learn? The message from Jerome Powell’s press conference was consistent with the policy statement and SEP. On the day, the FOMC struck a balance. The FOMC could have been more hawkish. The SEP could have raised the median 2018 DOT plot to four hikes, but fell one vote short. The policy statement also could have changed the balance of risks from “roughly balanced”, but did note that the economy had “strengthened.” That is, the Fed expects to continue to normalize monetary policy as the economy continues to normalize, but doing so gently. The policy statement, SEP and press conference succeeded I sending a hawkish policy message somewhat gently. This is consistent with the Fed’ objective of getting policy back to normal without slowing or ending the current growth cycle and/or causing undo disruption to the financial markets. Powell’s responses were calm, measured and, for the most part, confident. He was very direct in most cases, and succeeded in avoiding giving answers to nonsensical hypothetical questions.

March 21, 2018

FOMC Reaction: Powell's Path | US Economics & Strategy Ellen Zentner

Never mind the median rate expectation staying at 3 in 2018. Today the FOMC delivered a hike and a hawkish bias with the Chair pulling

the "cusp" up to 4 hikes and a steeper path for rates throughout. Our rates strategists suggest UST 2s30s flatteners, UST 3s10s flatteners, and short 10y breakevens. Our Key Takeaways: • As expected, the FOMC voted to raise its target range for the federal funds rate by 25bp, to 1.50%– 1.75%. Nearly everything else regarding the statement and projections was hawkish. • The Committee's view that the "economic outlook has strengthened in recent months" is a more hawkish nod to the tailwind effects of fiscal policy stimulus. • Reflecting both the effects of a tighter economy and a tolerance of an overshoot in inflation, the median inflation forecast was revised higher, to 2.1% in both 2019 and 2020. • While the median continued to reflect 3 hikes in 2018, a clear upward bias could be seen in the mean through 2020. • Despite the FOMC's more hawkish path, we continue to expect the Fed to hike 3 times this year, stopping after the September meeting to assess how much further it is willing to push real rates into positive territory, and facing tighter financial conditions. After pausing, we look for two additional hikes in 2019, where we think the tightening cycle ends at 2.625%. US Rates Strategy: • We understand why the yield curve steepened in reaction to the FOMC meeting: an unchanged 2018 median dot, a small increase in the longer-run dot, and a core PCE inflation projection above 2.0% in 2019 and 2020. However, we do not believe the reaction was appropriate or will be sustained. • We suggest investors take advantage of the

knee-jerk reaction by adding UST 3s10s flatteners and maintaining UST 2s30s flatteners. In short, we suggest being underweight or short 2s and 3s on the curve vs. overweight or long 10s and 30s. •

For the TIPS market, the more restrictive path for policy and Powell's comment that “Data doesn’t show an imminent inflation surge” support tighter inflation breakevens from here, in our view, and we suggest maintaining 10-year breakeven tighteners.

March 21, 2018

March 21, 2018

Global Macro Briefing: Whither Wages?

US Economics & Rates Strategy: Treasury Market Commentary, March 21

As DM inflation is set to rise, the pass-through into wage dynamics will become a focus for financial markets and central bankers. Thus far, wage dynamics have been subdued for cyclical and structural reasons. A recent pick-up still leaves wage inflation below par. DM economies operating at full employment: On our estimates, the DM output gap has now closed and is inching into positive territory. Despite unemployment making new cyclical lows and reported labour shortages rising to new highs, our DM wage tracker only points to modest increases in wage momentum. Modest wage inflation below the neutral level: Wage inflation remains below the neutral level – defined by labour productivity growth and central banks’ inflation objectives. Above this level, a cost push could hit profit margins or start a price-wage spiral. Phillips curve hints at limited cyclical pressures: While unemployment has fallen materially below its equilibrium or NAIRU level in a number of DM countries, there are few signs to date that the Phillips curve is starting to steepen. Pay rises remain below historical norms. Wider pool of labour still available: Broader metrics of labour market slack focusing on underemployment instead of just unemployment are pointing to a considerable share of workers across DM that would like to work longer hours than they currently do. Structural factors weighing on wage inflation: Several secular trends should keep wage inflation in check, including intense global competition, faster technological change, a shift towards temporary and part-time work and a rise in services and/or female employment.

DM wage growth starting to pick up but still staying below the neutral level

The mean FOMC rate hike expectation rises across all years as the 2018 median estimate remains at 3 hikes. Outlooks for growth and inflation are upgraded. Yields push higher post the hawkish interpretation but reverse initial moves into and following the press conference. UST 10y closed at 2.88%. 3-month Libor set 2.3bp higher in the morning, which pushed the June FRAOIS expectation up almost 3bp, to 47bp. However, the market more than reversed this move and June FRAOIS closed at 44bp. The reversal was triggered by the aggressive drop in repo rates. After opening at 1.61%, general collateral (GC) repo richened to 1.49% by 8:15 am, then to 1.40% by 11:00 am. Repo richened all the way to 1.00% by the end of the day. While, this is only a one-day move, it could be an indication that front-end T-bill and repo rates are high enough to attract demand. T-bills continued to see a strong bid, with 3m bills rallying 4.5bp vs FF rate and the 3m T-bill auction coming in very well bid with indirect bidders taking in a large share of the auction. The bid for repo and T-bills helped swap spreads widen strongly, especially in the front end.

We believe that foreign official institutions will offer a source of demand for T-bills as they withdraw funds from the foreign RRP facility and into T-bills given the cheapness in T-bills. This is likely to help Libor-OIS stabilize and tighten in April as we discuss in the publication Funding Supply and Demand. …Looking back at the projections noted in yesterday’s TMC utilizing Bloomberg’s EFCF functionality – forecasters expected a weighted average Fed top end of the range at 2.35% by the end of 2018. The Fed after today has an equivalent top end of the range excluding outliers with 6 dots at 2.25 and 6 dots at 2.50, meaning economist estimates for the Fed and where the dots were moved to are very close to exactly in line. Forecaster estimates assume GDP growth in 2018 of 2.8%, the Fed upped growth estimates to a central tendency of 2.6% to 3.0% for a central tendency midpoint of 2.8%. The estimates for headline PCE from the market forecasters for 2018, 2019, and 2020 are 2.0%, 2.0% and 2.1%, while the Fed central tendency midpoint for the same years is 1.9%, 2.1%, and 2.15% (interestingly the Fed has the same central

tendency forecasts for 2018-2020 for both headline and core PCE). Finally, the Fed foresees the unemployment rate below 4% in 2018, 2019, and 2020 at a central tendency midpoint of 3.7%, 3.55%, and 3.65%. These estimates are below forecaster projections of 3.9%, 3.7%, and 3.8%, meaning the Fed is slightly more optimistic than forecasters about the outcome for employment (yet even with those stronger expectations still can’t see inflation pushing much higher than target).

to a USD supportive surprise. The February core PCE will be released next Thursday.

Inflation may surprise to the upside

…GDP tracking We continue to track 1Q GDP at 1.7%.

March 22, 2018

FX Morning Hans W Redeker … The Fed has executed what our economists have called a hawkish hike. However, markets have given it a dovish spin, focusing on the Fed's benign inflation projection of 1.9-2.1% – running flat over the next few years – and the 2018 median dots staying unchanged, pushing the USD lower. The broader and domestically focused Russell 2000 index has reported moderate gains while the S&P 500 has lost ground into market close as reports that US President Trump is likely to announce USD50bn of tariffs against China today increased fears of increased trade tension. The LIBOR-OIS spread has widened further, reaching 55.5bp. Reasons to buy USD. We suggest buying USD this morning, offering the following reasoning. First, as endorsed by the Fed's comments and projections, markets have concluded that inflation may stay wellbehaved, citing the flatness of the Phillips curve or the strong belief that the Fed may fight inflation successfully if required. As such, the market may not be tolerant of inflation surprises to the upside. However, overnight we did see breakeven rates rise and US real yields fall. According to the Wall Street Journal, the US steel industry is already starting to raise prices for US consumers. We think markets and the Fed will either have to adjust their projections on real rates or on inflation. Importantly, the Fed acknowledged that the fiscal package boosted real GDP over this and next year. What is open is whether the fiscal package will increase the growth potential of the economy or increase inflation. Accordingly, markets are either wrong in their assessment of US real yield (real yield should rise) or they will have to increase their inflation expectations which, in turn, would endorse the Fed hiking faster later in the cycle. The USD may underprice this risk. USD weakness especially against Asian currencies including the CNY may push US inflation rates higher (see Exhibit), leading

Rising rates slowing issuance. Second, the USD has been used for funding purposes as illustrated by rising USD issuance by non-US (particularly EM) entities. Some of this funding has been via short-dated money market instruments such as Commercial Paper (CP). Outstanding CPs by foreigners have increased from USD244bn to USD310bn over the course of the past year. The recent rise of US LIBOR rates suggests that Australian banks are now 13bp better off issuing in AUD and UK banks are 20bp better off issuing in GBP. Slowing CP issuance within the USD market indicates the USD may be less used for funding purposes. A side effect of slower CP issuance may be the US LIBOR-OIS spread moderating in April. Rising growth divergence.

March 21, 2018

The Oil Manual: Tightness Ahead Seasonal headwinds to oil demand will become seasonal tailwinds from April/May onwards. After that, our balances show undersupply and further inventory draws. In recent days, flat prices, time spreads and refining margins have all been perking up. Our thesis is that this will continue into 2H. After some softness, oil market are perking up: Seasonality typically weighs on oil demand at this time of the year. However, we are only 3-4 weeks away from peak refinery maintenance, after which crude and product demand should accelerate. The front month Brent futures is already the May contract, and this will soon roll over into the June one. Hence, oil prices are already starting to reflect the period when seasonal tailwinds start to emerge.

We expect inventory draws to resume from April/May onwards: With oil markets 0.4 mb/d undersupplied in 2017, and demand set to grow 1.6 mb/d, supply would need to increase by 2.0 mb/d to balance the market. With OPEC and Russia likely flat, all of this would fall on the rest of the world. Despite US production growing 1.2 mb/d, on our estimates, and Canada and Brazil another 0.5 mb/d combined, we do not expect this gap to be closed. For 2018, we still see a global deficit of ~0.3 mb/d, concentrated in 2Q-4Q. With inventories already low, geopolitical risk is exacerbated: Expressed in days of demand cover, observable global inventories are already at the bottom end of the five-year range. With the inventory cushion largely gone, oil prices will likely be more sensitive to geopolitical risk factors again. Several 'hot spots' could provide ongoing price support. US shale is unlikely to derail our thesis: Guidance from 56 US E&P companies implies total shale growth of ~1.1 mb/d in 2018, and several factors likely limit growth much beyond that. Inside, we discuss takeaway capacity for the Permian basin for both oil and gas, which is set to become a hard constraint later this year. We highlight a range of inflationary pressures, as well as the issues around the 'super-lightness' of US shale and the growing mismatch that this introduces between the oil that E&Ps produce and what refiners can process. These issues are weighing on production estimates, which have been falling now for several months for the top 25 largest shale producers. Our forecast remains $75 by 3Q: Anticipating some further cost inflation, crude slate issues and infrastructure bottlenecks, we believe that 12 month forward WTI is anchored close to $60/bbl. Assuming a $5/bbl Brent/WTI spread, this pegs 12 month forward Brent at ~$65/bbl. If the inventory draws that we project materialise, we see the Brent curve go much deeper into backwardation, with the 1-12m spread approaching $10/bbl later this year. On this basis, we maintain our $75/bbl forecast for 3Q.

We expect demand to outstrip supply in 2018

March 22, 2018 [QuantWise] Morgan Stanley Insight: US Tariffs and the EU Response: What's the Ripple Effect? Our quant model shows that the recently announced tariffs on steel and aluminium won't likely derail our positive macro outlook. But extra levies on sectors such as cars could. The EU is likely to respond in an equivalent, WTO-compliant way.

March 21, 2018

General Mills Inc (GIS.N): Flattened by Freight GIS's Q3 results reflect heightened freight and supply chain-driven cost pressures, contributing to meaningful GM pressure and a further guidance reduction. We are reducing our 2018/19e EPS by 5/9% respectively and are reducing our PT to $48 based on 15x P/E and 10.5x EV/EBITDA.

21 March 2018

U.S. Rates Strategy - FOMC Review: Powell argued, a "Meaningful Improvement" in Demand from Fiscal Policies John D. Herrmann

…The Bottom Line: the Committee became more HAWKISH on the margin in their interest rate projections – just NOT as “optimistic” as our models forecasts ! The FOMC moves in a gradual and measured way – so, this is not too much of a surprise here – as we Previewed would be the case !!!

21 March 2018

US SNAP CHART A chart for your thoughts…Monetary policy may be tighter than you think Interest rates are rising, the yield curve is flattening and credit spreads are widening. And, the futures market has discounted a relatively large amount of tightening. All of this tells us that monetary policy is becoming significantly less accommodative. Future Fed actions should proceed relatively cautiously especially against the backdrop of a persistent inflation undershoot from target.

Bloomberg TERMINAL LINK HERE

would be appropriate. The 2019 and 2020 year-end funds rate projections did suggest a hawkish lean. In the end, however, we do not believe the news today should meaningfully alter market expectations regarding the outlook for Fed policy. We continue to forecast four rate hikes in 2018 and two rate hikes in 2019, consistent with our expectation that inflation will rise gradually toward (but not overshoot) the Fed's 2% target.

…Q&A Highlights from Fed Chair Powell's (First) PostFOMC Meeting Press Conference

Q: Would the Fed be willing to accept an overshoot of its inflation target like it tolerated an undershoot? A: I wouldn't characterize what we have done over the last five years as tolerating an undershoot of inflation. We were always pushing towards 2%. That is how we look at it…we are always going to be seeking 2% inflation, and in doing that, we are going to be considering by the way the other side of the mandate. We have to balance that against the deviation of employment from unemployment from its goal. …Q: More frequent press conferences? A: That is something that I'm going to be carefully considering. I have not made a decision about it. My colleagues and I are committed to communicating as clearly as possible about what we are doing and why we are doing it. I would want to think very carefully about it, and make sure that no one would take more frequent press conferences as a signal of the path of policy. …Q: Will the Fed tolerate an inverted yield curve? A: There are a range of views there. I think it's true that yield curves have tended to predict recessions, if you look back over many cycles. But a lot of that was just situations in which inflation was allowed to get out of control, and the Fed had to tighten and that put the economy into recession. That is not the situation we are in now…I think there are good questions about what a flat yield curve or inverted yield curve does to intermediation. It is hard to find in the research data, but nonetheless, I think those are issues that we will be watching carefully

Desk Strategy Desk Strategy

FOMC Statement, "Dots" and Press Conference Economics | Policy Flash 21 Mar 2018 The FOMC raised rates by 25 basis points as widely expected. There were no dissents. The "dot plot" showed no change in the median year-end 2018 fed funds rate projection, but participants were more evenly divided as to whether three or four rates hikes this year

US Markets Closing Notes, March 21st 2018 Cross Asset | Strategy Daily 21 Mar 2018 Recap and Comments: …While the lack of a fourth dot in the 2018 median clearly aided the much-maligned front-end of the curve, it’s worth noting that the margin for the 2018 dot to move up was razor thin. Just one more “dot” shifting up would have been enough to shift the balance. The plot is reproduced in today’s attachment – note that of the Fed’s 15 members that produced dots this month, 7

projected a year-end 2018 Fed Funds rate implying four or more total hikes in 2018 while 8 anticipated 3 or fewer hikes by year-end. …Looking at today’s price action alone you may think the decision was a dovish surprise, particularly as the USD continues to leak lower into the close even after weakening through the morning as the decision approached. But I think the overall tone was far from dovish. That said, a few instances of caution did shine through what was a blizzard of commentary on the strong footing of the economy. Among them was a reference to lack of clear upward pressure on inflation and wage inflation and the flatness of the Phillips curve. One other tidbit that stood out was Powell’s reference to the possibility for more post-decision press conferences. He said that he is carefully considering this but wanted to be sure that more press conferences wouldn’t be a signal about the path of policy. Clearly up to date with the pulse of the market, the Chair’s language suggest he is very aware that the market would interpret more press conferences as more flexibility to hike (or cut) in a given year, so was reluctant to take that step right now. Now we feel it is up to the data, and the inflation data more specifically, to give the Fed justification to continue along their projected path.

Desk Strategy

US 10y TIPS Preview | Buy on breakevens US Rates | Strategy Flash 21 Mar 2018 Tomorrow the US treasury will re-open its 10y inflation-linked bond for $11bn, or $10.4m/bp. The bond will be re-opened once more, in May, before a new 10y TIPs is launched in July and tapped in September and November. We like b/e TIPS in general and therefore recommend using the liquidity point to buy breakevens by switching out of 10y nominal paper. But 10y breakevens are not our preferred point of the curve, so we do not recommend switching from other TIPS issues.

Three reasons to like breakevens 1. US inflation may pick-up short-term. 2. Longer-term inflation pressures look real. 3. Oil

MARCH 21, 2018

ON OUR MINDS: US FOMC: ALL SOUND, NO FURY Summary: For all the concern over a more hawkish Fed today, especially in light of Chair Powell's Congressional testimony and Governor Brainard's recent speech, the Fed forecast a grand total of one additional rate hike over the 2018-2020 span, in line with our call. In fact, the overall Summary of projections (SEP) was very close to our expectations. The Fed forecast stronger growth and little additional inflation, despite lowering the unemployment rate next year and in 2020 to levels not seen in 50 years. That being said, the distribution of the dots clearly shifted up, and it would not take much to move the median funds rate projection higher in upcoming meetings, if the data warrant it. We continue to look for two more 25bps hikes in June and September. MARCH 22, 2018

TALKING POINTS A MORE PEACEFUL TIME AHEAD FOR TREASURIES The March FOMC statement and summary of economic projections (SEP) reflect a Goldilocks scenario, with upgrades to growth and employment, no payback on the inflation front and only a moderate hawkish repricing of the Fed path - which was made meaningless during the Q&A by the large uncertainty envelope the Fed Chair Jerome Powell created around the projections. Judging by the movements in equity and the rates space however, the market does not seem to be entirely convinced about the return of Goldilocks. The Fed delivered a 2bp hike, which was priced in with 100% probability ahead of the meeting. The median of the 2018 Fed dots was left unchanged, but 2019 and 2020 medians increased to 2.875% and 3.375% respectively, from 2.6875% and 3.0625%. Given the contingency of the 10yT range to terminal rate expectations in a late stage

cycle dynamic, the upgrade of the latter is particularly significant. The longer run rate moved higher to 2.875% from 2.75%. We see these changes as relatively hawkish relative to expectations. In a nod to the Goldilocks scenario, the Fed frontloaded upgrades to the growth and employment outlook, while leaving the inflation outlook roughly unchanged with only a minor uptick to 2.01% for the 2020 PCE (from 2.0% in December). Significantly, when asked if the c.3.4% terminal rate was significantly above the neutral rate and increased the probability of a recession, the Fed chair acknowledged that indeed the former is 40bp above the latter. However, he added that this is three years in the future, highly uncertain, and that he would not put too much faith into it. This exchange was quite reflective of the tone of the press conference where, by casting wide uncertainty envelopes around the dot plot, the Fed Chair effectively made the hawkish upgrades to SEP virtually meaningless. Confronted with the frontloaded nature of the upgrades to growth and employment, while the inflation outlook was left virtually unchanged, the Fed Chair attributed this to the flatness of the Phillips curve. Fortunately there were no follow-up questions on why the Phillips curve was so flat, because the usual answer (slackness in the labour market) is likely more difficult to argue at this point. Later in the Q&A, when asked about the slight downtick in NAIRU (from 4.6% to 4.5%), the Fed Chair noted how “we are not on the cusp of an acceleration in inflation” but that the committee is alert to sustainable periods of UR below NAIRU and the pressures that this could create. The comment on how the inflation objective is symmetric seems to go slightly against the “let the economy run hot” comments made by previous Fed Chair Janet Yellen - and how letting it “run hot” would help to remove hysteresis from the system. There were no questions at the Q&A on the recent Libor/OIS widening, which we find surprising ( see here ). The Fed Chair sees only moderate risks to financial stability while the committee does not see high levels of leverage or financial risk taking. Households are in a solid position and non-financial balance sheets are slightly stretched but there are no signs of defaults. Financials are less reliant on shortterm funding and therefore less exposed to liquidity shocks. So net/net only moderate risks to financial stability.

The 10yT faded the initial selloff and closed under 2.9%. The curve bull steepened, suggesting unwinds of hawkish positions going into the meeting and that perhaps the recent selloff at the frontend of the curve was overdone. On a first approximation investors look at the median of the dots, and then the attention turns towards the dispersion and risk around the median (how many dots would have to move to change the median, for example). None of these indicates much room for ambiguity around the three hikes for the 2018 scenario at this point. Equities closed in slight negative territory and the dollar index was down on the release.

MARCH 22, 2018

FX BLOG VENI, VIDI, MEH! (3P) Kit Juckes The Fed came, the Fed saw, but in the end it was all a bit of a non-event. The FOMC statement and the changes in the ‘dots' were marginally more hawkish than I, personally, had expected, but not enough to really change the outlook Where the Fed is heading in the longer term matters far more than how many hikes we see this year. The long-term median dot has risen 0.1% to 2.9% and the 2020 median dot has risen 0.3% to 3.4%. The Fed is relaxed enough about inflation to tighten at a slow and steady pace towards a low terminal rate. That would be extremely risk-friendly for markets globally were it not for concerns about the fiscal/monetary policy mix, the dangers of rising budget and current account deficits and nervousness about US trade policy. The result is neutral for the dollar, while US tariff announcements matter more than the Fed. Yesterday overall, was summed-up for me by the dollar falling in reaction to a Fed hike, while the Brazilian real rallied in reaction to a rate cut. The two charts below plot DXY against Fed funds, and EUR/USD against the ECB's Refi rate. The dollar has tracked Fed policy much less clearly than the euro has followed the ECB. The big dollar-moving events introduction and tapering of QE, don't show up here and rate moves have had little visible impact. By contrast, the highs and lows of EUR/USD are marked by the ECB's 2008 rate hike (folly) and the drawn out low that followed the ECB's combination of asset purchases and negative rates in 2015. In between, the Fed's policy aggression in 2009 helped the euro, the Greek crisis hurt it in 2010, the ECB's premature tightening in 2011 helped it temporarily before the sovereign crisis returned; Then Mario Draghi arrived to save the day, with ‘whatever it takes' taking EUR/USD back to 1.40 despite multiple rate cuts. That reaction is what triggered the rethink that in turn gave us the current policy. And some people wonder if it really matters who the ECB President is. Finally, the turn higher in EUR/USD came as political risk faded but was given a huge push when Mr Draghi told us that the ECB is going to taper its bondbuying programme, and here we are, waiting (impatiently) for the next big move, all the while nervous that it might not be just around the corner.

We will watch key EUR/USD levels, 1.2150 and 1.2450 for now, still nervous we may flush out stale longs, still expecting to see the 1.30 around the turn of the year. 2018 may require patience.

21 March 2018

Commentary March FOMC - Dovish reprieve for now 

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The Fed hiked 25bp as expected, and the dots drifted higher. The median 2018 dot remained at three hikes - but just barely. From our perspective, it will be easier for the dots to rise to four this year than for the Fed to deliver that fourth hike. Powell successfully navigated his first press conference without a significant misstep. One of the most anticipated questions was whether he would hold a press conference after every FOMC meeting; he only stated that it is something he is "carefully considering." Stay tuned.

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Rates: The yield curve bull steepened after the Fed delivered a message that was seen as dovish relative to expectations. We agree with the market reaction and remain long 3yr and in 5s30s steepeners.

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FX: The DXY should hold recent ranges, so the failure to punch through the March highs near 90.93 argues for a push back towards support near 88.25.

The dots moved up but not as much as we thought We had thought that the FOMC would revise higher their median dots in each year [link]. 2019 and 2020 were revised up, but the median for 2018 was unrevised. We had thought that it would be revised up by a hike, but one participant's projection was the difference. The funds rate path revision is consistent with the point we had made that the path of the funds rate is critical to the Committee, not the specific number of hikes in a calendar year. The longer-run dot edged up only a tenth, while we had expected it to stay constant. As we noted, that median was fragile, and the difference reflected one participant's shift. The statement was in line with our thinking What we got wrong We thought the median for this year would move higher. It did not, however at least four dots did move higher. We thought the FOMC would be leery of writing down an overshoot of their inflation target. They were willing to do so. We also thought that they would be more explicit about fiscal policy in the statement. They were not. What we got right We feel fairly vindicated in the overall stronger tone to the statement and the SEP. The FOMC clearly see a great deal of strength in the economy.

21 March 2018

What have we learned to revise our thinking? What is confirmed? We have learned that the FOMC does, in fact, have more tolerance for a mild overshoot of inflation relative to their target. That fact will weigh on our thinking about our own forecast for four hikes this year. Our forecast also has an inflation overshoot, but we were worried that the FOMC would shy away from writing it down. Moreover, we see higher inflation this year, so we are not changing our forecast for four hikes. Our general outlook that the FOMC is on a hiking path and will take the funds rate well above neutral to impart restraint on the economy is confirmed. The median dot in 2020 is 3.4 percent, two hikes above neutral. On balance, the FOMC sees strong growth, lower unemployment, and higher inflation, but the faster hiking is restrained, consistent with a "gradual" approach to policy that balances a symmetric inflation target with the real side of the economy

US Economic Comment

Reaction from strategy

Dots moved up at Powell’s first FOMC Seth Carpenter As anticipated, the Fed hiked rates 25 basis points We had said that the actual monetary policy was the most boring part of today. It was, but nevertheless, the federal funds rate target moved up 25 bps

The 2s10s yield curve steepened, but the 5s30s curve bear flattened. 2-year yields rallied by about 2bp, suggesting that the market was expecting the Fed to increase 2018 dots. Considering the uncertainty, the market reaction outside of the front-end was fairly tame. For the next two years, the market is now pricing in close to 4.8 hikes versus the Fed's expectation of six hikes. Thus, the front-end of the curve may be somewhat underpriced.

21 March 2018

US Economic Perspectives March FOMC Presser: Powell’s first, fade the SEP

choke off growth. Although we would love to have had the dots conform to what we wrote down, we feel pretty good with having called for a generally more hawkish tilt to the FOMC. 21 March 2018

Seth Carpenter

US Economic Comment

The policy decision was baked in The increase in the target for the federal funds rate was well anticipated. No news.

Spitballing tariffs on Chinese imports to the US

The dot plot reflects a gradual path of removing policy The economic outlook is stronger with more inflation Powell explained the balanced approach to growth and inflation. The Fed sees a very flat Phillips Curve. Powell emphasized the evidence so far of only a loose relationship between slack and inflation. That said, the overshoot in inflation in the SEP underscores the symmetry they see with respect to their inflation target. The SEP . . . fade it Powell took pains to point out the shortcomings of the SEP. First, he highlighted, that the only decision the FOMC took was the increase in the target rate. Second, the median is interesting, but not the whole story. The takeaway is that Powell was actively talking down the relevance of the SEP, especially the median itself. In response to a question about what could cause the Committee to hike four times this year instead of the three dots, Powell dismissed the signal in the three hikes in the median dot, saying that the FOMC could do more or less if the outlook changes. He was saying that people pay too much attention to the dots. Longer-run fed funds rate (and the natural rate and potential GDP) In Q&A, Powell noted that one should not expect frequent changes in the longer-run fed funds rate. It, like the natural rate of unemployment and the potential growth rate of GDP, as we have highlighted, are deep parameters that move little and take a good deal of evidence to change estimates. Press conferences Powell said that he will consider more press conferences but no decision has been made. He stressed—as we have—that the downside is that the market could make an incorrect inference about the frequency of funds rate changes. Bottom line Powell came through as we anticipated: straightforward and clear. He downplayed the signal from the SEP. He noted that the Fed would keep hiking, more than was thought in December, but that they are in no hurry to

Seth Carpenter News from DC suggests tariffs on China—perhaps this week Recent news reports suggests the Administration may put tariffs of up to $60 billion on imports from China. Census data show roughly $500 billion of merchandise imports from China annually; a ~10% across-the-board levy is a starting point. (Services imports are small.) Some overly simple arithmetic suggests a 10% tariff could raise inflation by about ¼ pp and lower output a similar amount in the short run. The fall in economic activity is likely smaller over the long run, because domestic production is likely to eventually rise. These baseline views, however, are subject to enormous uncertainty. If we treat the tariff as a direct increase in import prices Chinese imports are 18% of US imports of goods and services (more than double from 20 years ago, figure 1). If 10% tariffs raise these import prices 10%, aggregate import prices would rise 1¾%. A 1¾% rise in import prices would boost core consumer prices by roughly 0.2 pp [link]. If other producers (domestic or foreign) raise prices to match the implied rise in Chinese goods, the effect would be larger. In contrast, because the incidence of a tax is typically shared between the seller and the buyer, the net increase in import prices would likely be below the full amount of the tariff. Output effects are even harder Theory suggests lower output from reduced demand, increase input costs, and time is needed to build domestic production. The reduction in output might be attenuated by substitution from other sources including re-exporting from other countries (trade diversion or transshipping). With a unitary elasticity of demand, output would fall by as much as prices rise, roughly a quarter point. This assumption is admittedly arbitrary, but without more detail on the form of the tariffs, it is hard to know what elasticity would be best. Domestic production would likely take time to ramp up, implying that shortrun effects would be larger than long-run effects. However, the higher prices of intermediate goods are effectively an adverse supply shock. Items that are the most likely to be affected

Figure 2 shows categories where China is a major source of imports. Of note, China is the source of 80% or more of some categories, implying that trade diversion less likely, but that transshipping could be more important. Notable items like cell phones, tablet computers, and certain toys, where China is the predominant supplier to the US market, would be most affected by across-the-board tariffs on Chinese goods. Chinese retaliation would matter, but unclear The reaction from the Chinese is hard to gauge, but one obvious target could be soy exports from the US. Although the US only exported $13bln in soy to China last year, agricultural states w likely have meaningful leverage politically. Aircraft ($17 bln) and machinery and electronic equipment ($39 bln) are also plausible targets for additional import tariffs by the Chinese as they combine larger economic effects with political pressure. Conversely, because China is the source of roughly 80 percent of cell phones in the US, an export tax on cell phones could be treated as an effort to curb the trade deficit while hurting the US consumer through higher prices. The monetary policy response The Fed's reaction will clearly depend on the details of any tariffs and the economic effects that ultimately result. As a general rule, however, we think the Fed would react to an adverse supply shock by largely ignoring the inflationary effect, unless inflation expectations somehow show signs of becoming unanchored to the upside. The inflationary effect should be transitory. A large adverse shock to output would be more concerning, but there would have to be clear evidence of that direction.

The Fed Feels They Finally Have the Wind at Their Back … The significance of the Fed’s move in the face of this softer data is that the Fed has more confidence in the economy’s underlying momentum and appears to be more determined to normalize interest rates. Indeed, the FOMC’s median expectations for GDP growth for 2018 and 2019 were increased from 2.5 percent and 2.1 percent to 2.7 percent and 2.4 percent, respectively. Moreover, the median expectations for the unemployment rate were lowered by 0.1 percentage point in 2018, 0.3 percentage points in 2019 and 0.4 percentage points in 2020 to 3.8 percent, 3.6 percent and 3.6 percent, respectively. … Trust the Dots … One closely watched aspect of the March FOMC meeting was whether a majority of FOMC participants would opt for four rate hikes in 2018 as opposed to the three outlined at the December meeting. Seven of the fifteen dots now have the Fed raising interest rates four or more times this year, which is one more than in December. Eight participants are looking for three or fewer hikes (one of which has already occurred). A majority now sees three hikes in 2019, up from two in December and two participants now see the longer run federal funds rate above 3.0 percent, which had been the upper end of expectations at prior meetings. If economic growth is as strong as the FOMC’s current expectations, we would expect the Fed to raise interest rates more than it has currently outlined. We have four rate hikes in our 2018 forecast and expect another dot or two to join us in coming months

March 21, 2018

Rate Strategy

FOMC Review: Mix and match

Powell Fed committed to gradual tightening

March 21, 2018

Economics Group

Near term, we look for a little more steepening, and breakevens should climb •

The Fed Remains Resolute, Even in the Face of Softer Data As expected, the Fed hiked the federal funds rate by a quarter percentage point. The FOMC slightly boosted the target range for the funds rate in spite of slightly downgrading its view of recent economic conditions.

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The updated “dot plot” boosts Fed funds forecasts moderately for the next few years. The biggest change in the median rate is 19 bps for 2019. The FOMC forecasts suggest another 12 bps in 2020, putting the total increase at 31 bps through that year. Our overall takeaway is the tightening cycle may extend a bit but the pace should remain slow. In light of the static dots and Chair Powell’s calm comments, we look for Treasury and U.S. swap 2s/10s to steepen in the near term . The FOMC appears to tread the same path under Jay Powell as under Janet Yellen: slower than usual tightening while waiting for fundamentals to improve further. We expect Treasury 2s/10s to steepen another 5 bps in the next week or so. We

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will be surprised if 2s/10s steepens 10 bps. Even a 10-bp move would be small relative to the 25 bps flattening that has transpired since early February. Moving out the curve, we continue to think 10s/30s will steepen, perhaps nearing 40 bps by year-end. The long-end steepener should be propelled by a gradual Fed as well as a big jump in Treasury supply. The cautious FOMC should support TIPS . The Fed seems prepared to wait for a material pickup in inflation before removing the proverbial punch bowl. We look for breakevens to rise across the curve, until at least the next CPI release in April.

March 21, 2018

Economics Group Interest Rate Weekly

Short-term Credit: Cycles and Trends - Part I Short-term credit, especially from private banks, exhibits elements of both economic cycle and secular trends. Separating these two trends is critical to understanding the flow of credit that supports economic growth. March 21, 2018

Economics Group Interest Rate Weekly

Short-term Credit: Dispersion in Performance - Part II Beneath the top-line flow of short-term credit in the U.S. economy lies the dispersion in performance-from timing to quality-among the sectors of the economy. There is one monetary policy but many credit markets.

March 21, 2018

Economics Group

Special Commentary Brother, Can You Spare a Dime? Financing the U.S. Current Account Deficit

Executive Summary The U.S. current account deficit widened to a nine-year high in 2017, and we expect that the red ink will climb further going forward. Fortunately, foreigners remain willing financiers of the American current account deficit. FDI inflows exceeded $300 billion for the third consecutive year, and foreign net purchases of American securities jumped to their highest level since the record year of 2007. We look for modest dollar depreciation in coming quarters. But a full-blown rout of the greenback does not seem likely, unless something happens that leads foreigners to significantly reassess American economic prospects in coming years. U.S. Current Account Deficit Reached NineYear High in 2017 Recently released data show that the red ink in the U.S. current account totaled $466 billion in 2017, the largest deficit in nine years (Figure 1). The gaping deficit in international trade in goods ($811 billion) was partially offset by a sizeable surplus in international trade in services ($243 billion). In addition, the United States had a surplus in its primary income balance. That is, the income that Americans earned on their overseas investments last year exceeded the income that U.S. households, businesses and government needed to pay to foreigners on their American asset holdings by $217 billion. The United States also had a modest deficit ($145 billion) in its secondary income balance (e.g., unilateral government transfers to foreign economies, workers’ remittances, etc.).

March 21, 2018

Economics Group Architecture Billings Index Moderates in February The Architecture Billings Index (ABI) fell 2.7 points to 52.0 in February. Encouragingly, the ABI has remained above 50 for five consecutive months, meaning the majority of firms reported increased or stable billings. March 21, 2018

March 21, 2018

Economics Group U.S. Current Account Deficit Widened to 9-Year High in Q4 The U.S. current account deficit widened in Q4, and it will probably continue to grow larger. Fortunately, foreigners seem to be willing financiers of that red ink, at least for now. March 21, 2018

Economics Group

Existing Home Sales Rebound in February Existing Home Sales rose 3.0 percent in February to a 5.54-million unit pace, following two straight monthly declines. The South and West posted solid gains that offset sales declines in the Northeast and Midwest.

Foreign Exchange Research U.S. Dollar Down as Fed Shifts Only Its Longer-Term Dots

Summary. The U.S. dollar is down against most foreign currencies after a fairly mixed initial reaction to today’s Federal Reserve policy announcement. While there were some aspects of today’s announcement that were perhaps more hawkish than some expected, ultimately the currency market appeared to focus on the unchanged projection of a total of three rate hikes for 2018, which perhaps disappointed some who expected policymakers to signal a more aggressive near-term rate path. While policymakers signaled a steeper rate path in subsequent years, the likelihood of foreign central banks becoming more active in normalizing policy by then will keep downward pressure on the greenback over the medium term. Accordingly, we reiterate our expectation for broad U.S. dollar weakness and foreign currency strength over time. March 21, 2018 | Equity Research

Equity Research Fed Statement & Press Conference Constructive For The Capital Markets Christopher P. Harvey

The March '18 FOMC Statement is out and the Press Conference is over. The kneejerk reaction was a pop in equities, a give back and

then a small rally. Bond prices have stayed in a relatively tight range (a few basis points) and volatility is down on the day after being volatile. Here's the key message for equity investors, and it's so simple it almost sounds dumb but so be it. When the data becomes more Hawkish expect the Fed to be more Hawkish; and when the data becomes more Dovish expect the Fed to be more Dovish. For an Equity PM, it implies risk reduction as the data improves and increases of portfolio risk as the data wanes. It also suggests a type of equity ceiling to gains and a type of floor to equity losses. On a go forward basis, we think the FOMC Statement and Press Conference were very constructive for the capital markets. It was clear, transparent, and balanced. He tells you to follow the data but don't look too far ahead because he doesn't. Importantly, it leaves Chairman Powell plenty of optionality. For Active Managers, it's officially a stock picker's market. Game on and Good Luck!