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The Fed will believe it when it sees it (fiscal stimulus)

For the third time in this cycle, the Fed has raised its target range for key interest rates to 0.75% - 1%. However, the (lack of) change in its economic and fed fund projections has drawn most of the attention. Fed fund projections (or the "dot plot" as they are known) are almost unchanged since December: FOMC members are expecting three rate increases in 2017 and three more in 2018 (using median projections). Meanwhile, their growth projections have stuck quite close to 2% for 2017, 2018, and 2019.

The markets' reaction was unlike that to a "traditional" fed funds increase:

  • The equity markets reacted very positively to the fed funds increase. 
  • The credit markets also reacted very positively. Performance was especially notable for the lowest-rated issuers in the High Yield segment.
  • US long-term rates were down. The 10-year rate lost 7bp over the week to close at 2.50%.
  • The dollar has depreciated against virtually all currencies.

In recent months, the trend in the equity and credit markets are making the assumption of better economic prospects thanks to the measures that will be taken by the new US administration. Likewise, both consumer and business confidence indicators have shot up to high levels.

In parallel,the US economy still enjoys extremely accommodative financing conditions.FOMC members themselves are staying very conservative, apparently denying themselves any assumptions of fiscal stimulus in their economic scenario unless these are more clearly announced, which is why they have not adjusted fed funds projections upward. They are banking on just 2% growth in 2018, compared with almost 2.5% for the consensus. In a hollow, Janet Yellen told the press conference that the cycle of raising fed funds would accelerate only in the event of significant measures of fiscal stimulus.

Otherwise, these expectations are at odds with the real data. The latest figures point more toward a slowdown in US growth in the first quarter. The Atlanta Fed is forecasting growth of only 1.2% for Q1. That said, one should not give too much importance to an isolated figure.

As long as there is no further clarification on US fiscal policy - and this may take several months - markets will remain in a bogus situation, with very accommodating financing conditions (real rates close to zero as Fed refuses to accelerate), expectations of growth acceleration despite real data rather mixed.

2017-03-17-key-focus
Valentine Ainouz Bastien Drut & , Strategy and Economic Research at Amundi
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The Fed will believe it when it sees it (fiscal stimulus)
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