In Trump We Trust - Derivative Logic

Last Week: Interest rates fell while and global equities continued their advance on increasing evidence of improved US economic growth and rebounding inflation. Major US indices again notched record highs during the week, supporting the “In Trump We Trust” feeling of equity markets, though bond yields held steady. Despite the strong data, the yield on the 10-year US Treasury note fell to 2.415% from 2.43% a week ago, while 1-month LIBOR also fell to .7772 from .7805 the prior week. Oil prices dipped, and Gold and the US Dollar rallied. Volatility, as measured by the Chicago Board Options Exchange Volatility Index (VIX), edged up to 12 from 10.9.

After a continuation of the recent run of strong US economic data, hopes intensified last week that the reflationary period underway since late 2016 would prove more durable than the four prior upturns. January retail sales were a major bright spot, rising a better-than-expected 0.4%, while December sales were revised up 1% versus a previously reported 0.6% advance. Firmer consumer prices at both the headline and core level, buoyant manufacturing output and upbeat regional Fed manufacturing surveys – particularly the Philadelphia Fed’s manufacturing index – which soared to a 33-year high – added to the economic optimism.

In congressional testimony, Fed Chair Janet Yellen said that it would be risky to wait too long to raise interest rates and that the committee would consider hiking rates in coming meetings. Yellen holds press conferences once per quarter, and the two rate hikes this cycle have both come at meetings that were followed by press briefings. Her next press conference is scheduled for 15 March, with another on 14 June.

This Week: It’s a light, holiday shortened week with a few second-tier data releases on tap. Several Fed speakers will fill the quiet however, filling in the data gaps with a peek at how their views are evolving in response to recent events.

The minutes of the last Fed meeting are set for release on Wednesday, and will be subject to unique interpretation given the recent economic news showing a significant rise in Retail Sales, inflation and purchasing manager sentiment, rendering the Fed’s recent assessment of economic conditions outdated. Instead, markets will focus on gaining a better understanding of the Fed’s intended approach toward unwinding its massive balance sheet, specifically timing, intensity, and clues on the cohesion of policy makers toward coming to a final agreement.

Friday’s release of final Consumer Sentiment for February is expected to be lighter than the last gauge in January, which was the highest posting in the number since January of 2004 at 103.8. We expect some shine to come off consumer’s attitudes in the last month given the unnerving news headlines on the Trump administration in recent weeks. Consumer Sentiment is particularly important given the fact that consumers have been the driving force for economic growth over the last several quarters and are critical for growth in the near term as changes in fiscal policy take time to manifest.

Take-Away: After the very busy economic data calendar thus far this year, data releases will subside over the next several weeks, giving the Fed more time to analyze and respond. An acceleration in consumer’s wages remains critical to any sustained series of Fed rate hikes. The next signals of wage growth are January’s Personal Income and Spending data set for release on March 1^st, and February’s jobs report, set for release on March 10^th.

An acceleration in wage growth would give consumers greater confidence to spend, supporting a faster pace of consumption – the main driver of the US economy – and thus give the Fed greater confidence to tighten. Without it, US economic growth will eventually sputter.

While recent strong data could pull market expectations for rate hikes forward, we believe the current cautious Fed will be unconvinced before their next meeting on March 15. We’re sticking with our belief that we won’t see the first hike until June.

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