Month in Cash: Likelihood of 3 hikes fading

02-01-2017

The dots may have just run into reality. That’s our take on the Federal Reserve’s economic projections released at December 2016's Federal Open Market Committee meeting. The dot plot implied the Fed could be compelled to hike the target federal funds rate three times this year. We have taken a more conservative stance, still expecting only two moves, in March and September, with a third only as a possibility in December.

It’s all well and good that the dots showed policymakers optimistic about how the U.S. economy will fare this year. Chair Janet Yellen and other officials’ rhetoric also points in that direction. Cash managers such as us would certainly love for the positive momentum to translate into wage gains and increased prices that could push inflation to the Fed's 2% inflation target, and provide a bump in yield in the process. But we see enough uncertainty in the economic and political spheres to question that this will happen.

Simply put, economic statistics have not been bad but they have not been great, either. In January the housing market had some regional pockets of strength and regional pockets of slowdown. That makes sense because with an increase in rates, there are fewer new home sales and not as many housing starts. Retail sales were OK, but not anything to write home about. That’s especially troubling considering the holiday-driven consumer activity expected every December and January. On the other hand, inflation does appear to be picking up a bit. The consumer price index (CPI) is squarely above 2% at this point, the producer price index (PPI) is approaching 2% and the personal consumption expenditures index (PCE)—data Yellen is said to pay particular attention to—now hovers near that mark. Increasing inflation isn’t bad, as long as it is orderly and is accompanied by measured gross domestic product (GDP) growth. But we are not convinced we are going to see enough to trigger a third move, and, again, economic data has been mixed lately.

Then you have the political wild cards. While these may not have a huge impact economically, the more that people and business leaders get caught up in expecting the unexpected, the less likely they are going to reach in terms of investing or planning for the future. You can see that easily enough in the stock market, which hit great heights last week but has tanked given the past weekend’s crisis around President Trump’s executive order on immigration. In fact, what happened has clarified to us that the next four years are not going to be 100% rosy. Since the election, the markets have tended to focus on the positive economic implications of Trump’s potential policies. But now there is more of a realization that not all of these necessarily will be positive. In fact, some of his actions could lead to global fallout that could be detrimental to the U.S., especially if a trade war ensues. It is more of a balanced picture now, which solidifies our conviction that the Fed will undertake only two moves and not necessarily three in 2017. As a result, we have kept our Weighted Average Maturity (WAM) at 40-50 days.

The short end of the London interbank offered rate (Libor) curve remained elevated during January, with 3- and 6-month Libor bumping up around 4 basis points to 1.04% and 1.35%, respectively.