The markets have always reckoned the Fed would hike fewer times than officials
themselves thought but it's the swing more than the gap that now catches the
eye. Markets priced in close to 3 hikes in 2016 (after the initial one), back in
December. Now they put the odds of a single hike at only 50/50.After an awfully long quiet spell, the Fed officials too now appear to be backpedalling. NY Fed president Dudley noted yesterday that 'financial market conditions are considerably tighter than they were in December' and the Fed would have to take that into account come March (when the FOMC next meets).
Ten-year Treasury yields are 30 basis lower today than in December (1.88% vs 2.25%). Fifteen-year mortgage rates have fallen by 20 basis points. The euro and yen are smack where they were in December (and in fact are stronger than in December following yesterday's weak service sector ISM report). The S&P 500 is down by 7-odd percent since mid-December.
Back in November, the Fed let it be known that within some awfully wide bounds, it didn't care what the data were doing, it was going to hike rates in December and, unless things changed appreciably, it was going to deliver 4 more hikes in 2016. The data have weakened some since then but not by very much and inflation has risen. Interest rates, including mortgage rates, are lower and the dollar is unchanged. Only the stock market is 'tighter'. If this is what the Fed has to consider come March, it's time to get the old Texan Roger Fisher back into the FOMC saddle. He retired last March, of course, and with him, apparently, went his motto: markets should never be coddled.
Euro bounce, fiscal balances in focus
The sharp overnight jump in the EUR/USD is likely to be strengthen the case for the European Central bank to step up stimulus when policymakers meet next in March. A strong currency combined with weak supply-side pressures pose a fresh threat to inflationary expectations, delaying the scope of meeting the 2% inflation target.ECB keeps the door open for further policy easing, fiscal developments have also played a cohesive role. In 2009-10 the zone-wide fiscal deficit has narrowed from a peak of -6% of GDP to -3% by 2013 and to -2.0% of GDP by 3Q last year. Primary deficit (excluding interest payments) has improved by a larger extent, turning modestly positive last year. Austerity measures by way of tax hikes, cutback in wasteful expenditure and paring of welfare payments have helped to contain spending, even as revenues took a hit from weak growth.
Lower fiscal deficits meanwhile slowed the built-up in government debt levels, but weak/negative growth in the years since the global financial crisis prevented a decline in the aggregate debt levels. This saw government debt as a percentage of GDP rise from 67% in 2004-05 to 78% in 2009-10. The build-up in debt levels continued in the subsequent years (amidst recessionary conditions) peaking at 93% of GDP early last year, before inching down to 91.6% by 3Q15.
The fiscal/debt metrics are on the mend at the zone-wide level, the improvement is not uniform across member countries. Amongst the core economies, Germany is close to registering a modest fiscal surplus last year, along with a sub-3% deficit reading for Italy. On the other hand, France and Spain are likely to stay above the -3% of GDP mark, exceeding the red-line drawn by the Stability and Growth Pact. Amongst the rest, Portugal's deficit remains above 4%, while on-going fiscal austerity in Greece is likely to lower its deficit to a shade below 4% last year.
Growth is required for austerity to be succeed and by extension, deficits/ debts to narrow. In this respect, while fiscal math is on the mend in the currency bloc, recovery needs to take hold amongst the member countries to ensure the improvement is broad-based and driven by higher revenues rather than aggressive expenditure cuts.
US ISM non-manufacturing index drops in January over retail sales weakness
US ISM non-manufacturing index for January dropped to 53.5 from 55.8. The index continues with a sharp downward trend from the July's peak of 59.6. The US Fed officials will be worried that the slowdown in mining and manufacturing is "spilling over" to the rest of the economy, just as it did before the 2001 recession. Hence any possibility of a rate rise in March seems to have faded further.The decline in the ISM non-manufacturing index might be due to the recent weakness in retail sales. However, much of the slowdown is expected to be because of weather, with sales of motor vehicles recovering in January. This implies that the real consumption growth is expected to accelerate in H1 2016.
The underlying details slowed throughout the board. The business activity index dropped from 59.5 to 53.9, while the new orders component fell from 58.9 to 56.5. The employment index dropped from 56.3 to 52.1, leaving it at a level steady with gains in private services payrolls of about 150,000. The ADP survey, in contrast, indicates that the private payrolls rose 205,000 in January.
"Overall, we acknowledge this is a disappointing development. But we still think the risks of a US recession are low. GDP growth should still be 2.5% this year", says Capital Economics.