Global Economic Perspective: March

Investors Adjust to More Hawkish Fed, but US Growth Set to Remain Modest for Now

Even though confidence among US businesses and consumers has been lifted by the advent of a new administration, the question of whether this buoyant mood is likely to translate into a significant pickup in US economic growth remains unanswered, in our view. The Fed looks set to tighten monetary policy further, as inflation and unemployment move closer to its targets—underlining the strength of the domestic economy—and surging equity markets have added to already elevated consumer confidence. But the potential for delays and adjustments to anticipated growth-boosting policies poses risks, and we think the extent of these challenges may be underestimated.

Speculation about policy change has largely monopolized the attention of investors in the months since the US elections, but monetary policy came sharply back into focus during February. In her testimony to Congress, Fed Chair Janet Yellen—usually seen as one of the more dovish policymakers—delivered remarks that added weight to perceptions of a more hawkish stance from the Fed, although she was careful also to point out the considerable uncertainty around the outlook, particularly surrounding the new administration’s economic plans. In reaction, market expectations that rates would rise three times in 2017—the Fed’s indicated path for monetary policy—immediately increased, having fallen as low as 24% in early February, following the announcement of disappointing wage growth.

This re-appraisal of the likely path for US monetary policy gathered pace when some of the other more dovish members of the Fed’s rate-setting panel appeared to change tack and indicate they believed rates should rise soon. Following further remarks from Fed Chair Yellen in early March, it was clear a rate hike at the next Fed meeting was all but certain, and the release of a strong labor market report for February removed any last potential doubts over such a move. After repeated episodes stretching back to 2013 when the Fed had failed to deliver predicted rate rises, market participants were now faced with a specific warning from Fed Chair Yellen that policy accommodation would be removed more quickly than in previous years. As a result, market expectations were rapidly revised, so that a total of three rate hikes over the year was now seen as the most likely scenario, and predictions of four increases even gained some traction. The Treasury market initially remained fairly resilient to this reversal of sentiment, but by early March benchmark yields had reached their highest level so far this year, ahead of the Fed’s confirmation of its decision to raise interest rates.