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Between several hawkish comments from Fed policymakers and markets hearing everything they needed to in the US president’s address to a joint session of Congress, the odds of a March rate hike have surged. In turn, with short-term US yields shooting up, the US Dollar Index (DXY) has been quick to take out the February high set on February 15.
Chart 1: DXY Index & US 2-year Yield 4-hour Timeframe (January 9 to March 1, 2017)
In the past 48-hours, we’ve heard from the Fed’s Kaplan, Williams, Bullard, and Dudley, all of whom have painted a clear picture that a March rate hike is not merely an outside threat, but a very real possibility, thanks to the economy being at “full employment” and inflation (both headline and core) pushing through the Fed’s medium-term target of +2%.
Confirming the need for higher rates, at least in the FX and rates markets’ minds, was the speech given by US President Donald Trump last night. While details were still lacking, it’s clear that there are specific policy goals that the 45th President of the United States intends to accomplish in order to boost US growth: a $1 trillion infrastructure spending program, funded by both public and private sources; and a tax reform plan that would cut taxes for both consumers and businesses, in what was a vague endorsement of a border-adjustment tax scheme.
As per the Mundell-Fleming framework (or IS-LM-BOP model), given the United States’ high capital mobility, loose fiscal policy should lead to a rise in inflationary pressures, which in turn should necessitate tighter monetary policy from the Federal Reserve. Indeed, markets have gravitated towards this point of view, with the odds of a March rate hike surging up to 80% today thanks to the commentary from Fed officials and speech from US President Trump. Markets are now pricing in hikes in March and September, with north of a 50% chance of a third hike this year in December.
