Analysts at Brown Brothers Harriman explained that many investors and journalists were worried about the US slipping into a recession.
"However, Q4 15 growth was revised up, and Q1 16 growth is returning to the post-crisis trend pace near 2%. Moreover, the evidence is beginning to accumulate to suggest that the oil and inventory headwinds on the US economy may be dissipating. March Empire State survey and today's Philly Fed survey were stronger than expected, including the forward-looking new orders components. This suggests upside potential to the next manufacturing ISM/PMI.
A combination of temporal inconsistencies, like playing down market-based measures of inflation and then citing them, or saying that the economic assessment has not changed much and cutting the number of hikes anticipated to 2 from 4, raises questions about the Fed's credibility. Fed officials, who are well aware of market developments are cognizant of these concerns.
We are concerned that the Federal Reserve over-corrected its December excesses. We are concerned that the market has overreacted to what had generally been anticipated., including the more to two hikes. While investors see the mote in officials who change their forecasts and forward guidance, they are less aware of the beam of their own shifts.
At the end of last year, the December 2016 Fed funds futures contract priced in more than two hikes this year. On 30, December 2015, the December 2016 Fed funds futures implied 90 bp yields. On 11 February, it had fallen to 34.5 bp. It now is 60.5 bp. Are market guesses and forecasts more credible than the Fed? It may depend on when the question is answered.
Many participants are frustrated. The BOJ, ECB, and today, Norway's central bank, eased policy, and their respective currencies have rallied. The media often portrays this some kind of new development, which it also says, raises questions about the credibility of central banks. Balderdash. Markets are not only incredible aggregators of information but are also a large discounting mechanism. Often the dollar, for example, would sell-off on anticipation of QE and rally on the fact.
Norges Bank's rate cut today was widely anticipated. The ECB move was widely anticipated. The BOJ's at the end of January was a notable surprise. A few days earlier, Kuroda had seemed to rule out negative interest rates. However, we suggest that the negative rate surprise fanned the anxiety that had been driving markets since the start of the year. It spurred the unwinding short yen hedges and the buying back of the yen that was used to fund the purchase of risk assets.
As is well appreciated, monetary policy impacts with a lag. The Fed's leadership has cautioned that delaying rate hikes too much could spur more aggressive moves later. This has not changed. Although the pricing of the Fed funds futures and discussions with market participants do not agree (yet), we continue to think a June rate hike remains the most likely scenario."
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