Politics Not Economics Is Driving The Markets

The US dollar has been correcting lower since mid-December. Interest rates have begun moving in the dollar’s favor, and the equity market is again knocking on record highs. The US economic data, coupled with Fed comments, keep the Fed on track to hike rates.

Even with the weaker than expected wage growth in January, investors saw a greater chance of a June hike. Yellen has warned of a “nasty surprise” if the Fed waits too long, and even the dovish Chicago Fed President Evans seems endorsed two, and possibly three hikes this year.

This year is different than 2015 and 2016 when the Fed hiked rates in December both years. The Fed is more confident of the underlying resilience of the economy and more sure that price pressures will continue. In December, the FOMC statement said that “…inflation is expected to rise…”  Last week the FOMC statement said that “…inflation will rise…”

The five-year breakeven (conventional yield minus the yield on the five-year inflation protected security) closed above 2% for the second consecutive week. A year ago it was a little more than 1%. The 10-year breakeven has closed above 2% for four consecutive weeks. It is approaching 2.10%, the highest since September 2014.

The US economic calendar turns lighter next week. However, after a disappointing first estimate for Q4 16 GDP, the typically more conservative NY Fed GDP tracker is pointing to 2.9% growth in the current quarter. The Atlanta Fed sees the economy tracking 2.3%.

The unpredictable nature of the new US Administration, and its seeming willingness to antagonize allies and rivals alike, and making arbitrary judgments, appears to have increased the uncertainty. Although Administration officials articulate pro-growth sentiment, there is a concern that other policies will undermine the investment climate.  

Still, as the Trump Administration begins turning its attention to its economic agenda, investors’ confidence may be bolstered. Already a group of large exporters, including GE, Boeing and Oracle are forming a lobby to support the border tax. The executive order to review Dodd-Frank signed before the weekend, sent the S&P 500 financial index up 2%, with several of the large bank shares rallying the most in three months.