The Daily Prophet: Fed Hawks Have Markets Already Gaming 2018

Connecting the dots in global markets.

Within the past 48 hours, markets have gone from assigning relatively low odds of a Federal Reserve interest-rate increase on March 15 to betting that it's a sure thing after some surprisingly hawkish comments from central bank officials. But that's only half the story.

Even though the central bank hasn't even raised rates yet this year, Wall Street economists are already rushing to boost their estimates of how high rates will go not only in 2017 but in 2018, too. Take Morgan Stanley, which now sees three hikes this year and four next year, up from the two and three it previously forecast. That would bring the end-of-2018 range to between 2.25 percent and 2.50 percent, up from the current 0.5 percent to 0.75 percent. The derivatives market is taking notice, with traders pricing in a higher terminal rate.

Fed policy makers are finally "coming across as more confident,'' Ed Yardeni, president of Yardeni Research Inc. in New York and who’s been analyzing the bond market since the 1970s, said in a Bloomberg Television interview. "The global economy is doing better.''

Yardeni's observation is important because too often in recent years the Fed has delayed rate hikes because of weakness in the global economy. But this year is shaping up to be the most synchronized for global growth since the immediate aftermath of the last recession. Confidence in the euro area is stronger than it's been since before the debt crisis in 2011, and while unemployment remains double the U.S. level, it has been falling faster than forecast. Asia’s trade recovery is being driven by looser monetary policy and China’s stimulus that was rolled out last year amid fears of a sharp slowdown.

A synchronized expansion means the global economy doesn’t need to rely as much on the U.S. for growth, which could ease the upward pressure on the dollar. For now, though, the greenback is back on a tear amid prospects for higher rates in the U.S. Yield-starved global investors are rushing to buy high-yielding dollar-denominated assets. For example, they can get 2.16 percentage points more in yield on two-year Treasuries than they can on similar maturity German bunds. That spread has grown from 1.84 percentage points in January and is the highest since 2000.

If investors were concerned about the health of the global economy then emerging-market borrowers probably wouldn't be able to sell bonds at a record pace. Emerging-market issuance in dollars and euros this year has already exceeded $100 billion, Bloomberg data show. That’s almost 20 percent more than the previous record for the period in 2014. What's remarkable is that it's getting cheaper for them to borrow, with emerging bond yields easing about half a percentage point since the U.S. elections in November. That may not last if the Fed does accelerate the pace of rate hikes.

There was some good news today for consumers of energy, which is just about everyone on the planet. Oil tumbled the most since January, dropping to a three-week low in New York as record U.S. crude stockpiles jeopardize OPEC’s efforts to drain a global surplus. U.S. stockpiles expanded to 520.2 million, the most in weekly government data going back to 1982. As the Organization of Petroleum Exporting Countries and 11 other nations trim supply in an effort to end a glut, U.S. producers are ramping up and potentially offsetting the curbs. OPEC's output fell to 32.17 million barrels a day in February, a drop of 65,000 from January, the first month of the agreement.

The cavalcade of Fed speakers this week concludes Friday when Chair Janet Yellen and Vice Chairman Stanley Fischer give speeches on the economy and monetary policy at separate events.  It's unlikely that Yellen and Fischer will diverge from the consistently hawkish messages heard so far. If they do, it would raise questions about the central bank's credibility after the market has given them the green light to raise rates this month. Policy makers have been criticized in recent years for talking tough on rates only to back off at the last minute.   

If you'd like to get The Daily Prophet in e-mail form, right in your inbox, please subscribe to this link. Thanks!


Why You Should Be Optimistic About Stocks: Charles Lieberman

The Most Interesting Man in the (Bond) World Speaks: Scott Dorf

Trump’s $1 Trillion Infrastructure Dream Faces Old Nightmares

Two Percent Inflation Not Enough for Draghi to Shift Policy

China’s Markets Chief Exits Crisis Mode With Cautious Reforms

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.