President Trump addressed a joint session of Congress for the first time on February 28th. His speech reiterated many of his key economic and tax initiatives, including $1 trillion of infrastructure spending, income tax reform, corporate tax rate cuts, and “free trade but… fair trade,” presumably including trade agreement renegotiations and a border adjustment tax. The specifics remain to be announced, but the reflationary, stimulative tone remains. Earlier in the month, Treasury Secretary Steven Mnuchin said that tax reform would pass congress by August, but cautioned the impacts to growth would not be immediate, likely taking several years to be fully felt.
The European Commission released updated economic forecasts in February with a projection of 1.6% GDP growth for the Eurozone, slightly behind 2016 growth of 1.7%. The report also cautioned around global policy risks, including changes in U.S. trade policy, Brexit and ongoing concerns regarding Greece’s bailout. Negotiations regarding options for Greece to meet its debt obligations are ongoing. Dutch elections in March and French elections in April both pose risks for the European Union with anti-EU candidates having substantial support.
European Purchasing Managers Index rose for the sixth consecutive month, increasing to a level of 55.4 from 55.2 in January. This level represents the highest level in over five years in Europe. Consensus is for a 1.9% increase in inflation for February and for unemployment to remain at 9.6%, the lowest level since 2009.
In China, the Manufacturing purchasing managers index rose to 51.6, exceeding estimates of 51.3 and Caixin’s private manufacturing PMI increased to 51.7, both indications of expanding manufacturing.
At the Fed’s January 31 – February 1 meeting, the Fed governors unanimously voted to keep the Fed Funds range unchanged in the 0.5% – 0.75%, though noting “further strengthening” in labor markets and improving consumer confidence and business sentiment. The Fed reinforced their position regarding reinvestment of its $4.5 trillion balance sheet. The Fed anticipates continuing reinvestment “until normalization of the level of the federal funds rate is well under way.”
In February 14th testimony to the Senate Banking Committee, Chair Yellen reiterated that view on the Fed’s balance sheet. She stated that the Fed’s goal in allowing the balance sheet to wind down would be to “find a time when we judge that our need to provide substantial accommodation to the economy in the coming years is minimal” and that “the federal funds rate has reached levels where we have some ability to address weakness by cutting it.”
On February 28th, San Francisco Fed President John Williams said he expects a rate hike would get “serious consideration” at the next Fed meeting, which is to be held on March 14-15. At the end of February, Fed Funds Futures implied a 52% likelihood of a rate hike at the March meeting. These probabilities have moved higher, exceeding 80% as of this writing, after Mr. Williams’s comments and President Trump’s speech.
In our view, while growth and inflation expectations remaining solid, more recent economic data including growth and productivity remain mixed. The coming months will be shaped by the shifting perceptions around the likelihood of implementation of President Trump’s policies and the path towards realization of growth expectations. The Fed has reemerged as a market focus regarding timing of the next rate hike, however, our focus remains on the trajectory of the rate hike cycle and the Fed’s balance sheet, where we have yet to see a shift in policy that would warrant repositioning. U.S. fixed income appears well supported with an improving outlook for U.S. growth and normalizing, but accommodative, monetary policy.