Fed: Two steps up, one step back down - SocGen

In view of the Kit Juckes, Research Analyst at Societe Generale, Fed officials sounded less dovish than they did a few months ago.

Key Quotes

“That’s not the same at all as sounding hawkish. With inflation edging higher, the tendency to dither is alive and well. The dollar benefits, but only because policy is SO easy in Japan, the eurozone and Beijing. It will be case of two steps up for the dollar followed by at least one back down. That’s going to leave investors tempted to buy dips in higher-yielding and commodity-sensitive currencies, too.”

“There is virtually no correlation between the Fed’s favourite measure of inflation, the core PCE deflator, and wage growth. There’s a weak relationship between inflation and unemployment (an r-squared of 12% between PCE and the unemployment rate). But there IS a decent (negative) correlation between wage growth and unemployment (the correlation is better between wages and the broader U-6 measure of unemployment. This suggests that a 1% fall in the U-6 unemployment rate from here (to 8.4%) would drag wage growth above 3%, but what it would do for inflation is much less clear.”

“All this means that as unemployment falls towards the Fed’s definition of full employment, and as core PCE moves towards the 2% target, the FOMC is on track to raise rates two or three times this year (SG thinks two). But because the tightness of the labour market is having a very uncertain impact on inflation itself, the Fed has licence to continue market-watching and is unflustered by a real Fed Funds rate of -1% when real GDP growth is just under 2%.”

“So Treasury yields, in both real and nominal terms, continue to grind higher but only very slowly. For every two steps up, there is at least one back down. The dollar is following the path of rates without satisfying the bullish consensus much. And investors, who feared a ‘riskoff’ period as monetary policy tightened, are sent off in the direction of higher-yielding currencies. The global economy is supported by easy Fed, BOJ, ECB and PBOC policies, and commodity prices are rising. No wonder 2017’s best currencies include the RUB, AUD, BRL and ZAR, all up by over 6% against the dollar and 5% against the euro.”