FOMC: Ticket to hike – BMO CM

Douglas Porter, Chief Economist at BMO Capital Markets, suggests that heading into Janet Yellen’s penultimate FOMC meeting as Fed Chair this week, there is precious little debate on the outcome—a 25 bp hike is all but fully priced in.

Key Quotes

“There may be the odd voice in the wilderness suggesting that, before she gets to saying goodbye, the Chair ought to think twice on the hike due to subdued inflation and a flattening yield curve. But the latest round of economic data, as well as recent financial market and policy developments, offers no resistance. Thus, for the third December in a row, it’s beginning to look a lot like Fed tightening. In brief, here are some of the latest factors that simply push on the open door for such a move:

• A robust U.S. job market. November payrolls handily topped expectations at +228,000 and the jobless rate held fast at a cycle low of 4.1%. True, wages remain modest at 2.5% y/y, but that may not last with a record high share of small businesses (24%) planning to increase employment amid an already tight market.
• Fiscal stimulus is coming. Since we last published, the Senate voted in favour of tax reform, greatly increasing its odds of coming into law. While there are still reconciliation hurdles, the operating assumption at this point is that growth in 2018/19 will get a moderate lift from tax cuts.
• Congress approved a short-term spending bill (oh, the drama). While this just kicks the can down the road two weeks, at least it removes the issue from the FOMC’s plate, and perhaps stays out of the way of the tax deal.”

“Beyond those domestic factors, there are also the broader global developments which would lean in favour of a more general case for monetary tightening. To wit:

• Brexit negotiations made “sufficient progress” to move on to trade talks between the U.K. and the EU. It looks like Britain is headed for a soft Brexit, and gilt yields are now almost all the way back to pre-vote levels.
• Global growth keeps powering along. The latest evidence comes from doubledigit yearly gains in China’s November exports and imports (the latter up 17.7% in dollar terms). Euro Area Q3 GDP growth was 2.6% y/y (even better than America’s 2.3% in that quarter), while Japan’s pace was revised higher.
• Bitcoin mania—and mania may be an understatement; the cryptocurrency’s rocket ride would make North Korea’s engineers proud. While we doubt this topic will rate a specific mention in the FOMC minutes, it is symptomatic of asset prices at risk of bubbling over, in part due to ultra-loose monetary policies.”

“Note that if the Fed does indeed hike this week, 2017 will mark a rare time when policymakers did precisely what they expected to do at the start of the year. Going back to last December, the much-beloved dot plot showed that the median call was three 25 bp rate hikes. While core inflation looks to come in about 3 ticks shy of where they expected it a year ago (they were at 1.8% Q4/Q4), GDP will be about half a point stronger (vs the projected 2.1% pace Q4/Q4) and the jobless rate will be almost half a point lower (they were at 4.5% for Q4).”

“So, while it may be true that inflation has been lower than expected, growth actually outperformed, providing ample justification for the rate hike plan to proceed. That market-friendly combo (low inflation, solid growth) also provided fuel for the year’s buoyant equity performance.”