Last Week: With little on the US calendar, US yields took their cue from sustained gains in equities and oil and actions by the European Central Bank (ECB). The ECB unleashed a massive and impressive package of monetary measures to weaken the Euro, boost bond prices, raise growth and inflation expectations and free up liquidity at banks and in the private sector to further ramp financial asset prices. As of last Friday, the QE bazooka accomplished none of these. It seems market is worried the ECB knows something it doesn’t, prompting even the most bullish on Europe to question the need for so much ECB firepower in a single day. For the week, the 10-year Treasury traded up 7.3bps to 1.98%, while 1-month LIBOR declined 6bps to .4362%.
This Week: The Fed’s March FOMC meeting on Wednesday dominates the week, but first-tier data releases on inflation, retail sales, the consumer and manufacturing will also be closely watched. We don’t expect the Fed to hike, thus the focus will be on the Fed’s forward guidance. We expect the median projection for the Fed Funds rate to incorporate 75 basis points of tightening this year – down from 100. The market expects only around 30 basis points of tightening by year’s end.
Take-Away: Ask yourself these questions: How much has the outlook for the US economy changed since the Fed’s December 2015 meeting? Have what the Fed calls “global economic and financial developments” reduced the need for Fed tightening? We think the answer to both questions is: Not that much. That being said, we believe the Fed will remain on hold this week, and look toward its June meeting for the next rate hike.
No matter what Fed does this week, the key issue for future Fed policy is if the unemployment rate keeps falling. Why? The unemployment rate is an important gauge of both the inflation and labor parts of the Fed’s mandate since low unemployment is seen as a leading indicator of inflation pressures. As long as the unemployment rate keeps falling, the pressure on Fed officials to hike will increase, especially if core inflation keeps edging up, which we expect.
Current Market Pricing
10 year Treasury