High Noise To Signal Drives Markets

The capital markets are particularly difficult to navigate at the moment. The news stream is noisy. There are three issues that are confusing: the Fed, Greece and Australia.  

How to think about the FOMC minutes? The market clearly saw the minutes as dovish and reducing the chances of a June lift-off. The debt market rallied, with the December 2015 Fed funds implied rate slipping below 50 bp, and the dollar came off. However, we think that 1) the market is exaggerating the dovishness and 2) events since last month’s meeting have to be taken on board.  

We have argued that the real signal from the Federal Reserve comes from its leadership, Yellen, Fisher, and Dudley. Their signal is most clear in the FOMC statement. If someone disagreed with the statement, they would dissent. The minutes have a high noise to signal ratio. The minutes read as if there may have been a push from the hawks to hike rates in March.  The dovish tint to the minutes, we suspect, was a push back against them. 

Since the FOMC meeting, several Fed officials have indicated that a June hike was still on the table. The international headwinds have slackened since the FOMC meeting. For one, Fed officials, like all of us, have learned that the German and Japanese economy appear to have grown faster than the US in Q4 14. A resolution to the existential issue posed by Greece will be resolved by the time the Fed meets next month.   Also, since the Fed met in January, they have seen the continued improvement in the labor market, including a recovery in average hourly earnings.  

Some are concerned about the slowing of the US economy in Q4 and so far in Q1. However, this too should be kept in context of 1) well above trend growth in April-September and 2) the combination of labor force growth and productivity, suggests trend growth is in the 2.00-2.50% area rather than above 3% as it was understood prior to the crisis. Yellen’s testimony before Congress next week is the next important event for insight into Fed-think.  In the mean time, we still expect the Fed to modify its forward guidance and to shift away from the date-specific “patience” that will keep the door open to a mid-year hike.