Fed: March hike may seem soon, but May is looking particularly interesting - BBH

Analysts at BBH note that the Fed's leadership--Yellen, Fischer, and Dudley--sounded increasingly confident about the trajectory of the economy and prices.  

Key Quotes

“While a March hike may seem soon, but May is looking particularly interesting.  As we have argued, the Fed is a bit hamstrung by its own transparency measures.  It has regularly scheduled quarterly press conferences, which are used to explain policy and policy views (economic projections).  In effect, this halves the number of "live" meetings to four. As the pace of normalization is poised to accelerate, it is clearly in the Fed's interest to re-animate, as it were, the other half.”

“To do so requires the Fed to raise raises at a non-quarterly meeting, and May is next to such opportunity.  Others are drawing the same conclusion from the Fed's comments, especially Yellen's testimony.  Last week, the implied yield on the March Fed funds futures contract ticked up one basis point to 0.69% yield.  The implied yield on the May contract rose 3.5 bp to 0.785%.  The June contract's implied yield rose three basis points to 0.85%.”

“Some caution that the market has a Fed hike and tax reform discounted.  Short-term positioning, they argue, is already extremely long dollars.  While some tax reform may indeed be anticipated, and Yellen acknowledged that the anticipation of fiscal stimulus might be helping elevate equity prices, remember the argument is that due to the economic identities and purchasing power parity that the dollar will rise to offset the border tax (20%-25%).  Clearly, with the dollar down against all the major currencies so far this year, it is hard to say tax reform is fully reflected in current prices.”

“It is true that one hike in H1 17 has been largely discounted.  A second has also been priced into the strip, but the market is pricing in about a one in four chance of a third hike.  This has room to adjust.  And the speculative market does not appear to be extremely long dollars.  The latest CFTC Commitment of Traders report that covers through February 14, show the net short euros to be near seven-month lows, and the speculative participants are short US dollars against the Canadian, Australian and New Zealand dollars.  In fact, the speculators in the futures have not had such a large net long Canadian dollar position in five months.  The net long speculative position in Australian dollars is the largest in more than two months.  Since the end of last year, speculators have cut the net short yen positions by a third.”

“The FOMC minutes release is the highlight for the US this week.  After the Yellen's recent testimony and comments from various other officials, it the minutes is unlikely to add much to the already available information set.  It may be interesting to see how the Fed's balance sheet was discussed and the preliminary thinking about fiscal policy initiatives.”   

“Yellen batted away concerns that Dodd-Frank was inhibiting lending and bank profitability. She pointed to the dramatic increase in commercial and industry loans and the health of US banks both in absolute terms and about other countries that did not impose it (like European banks).   Dodd-Frank may eventually be treated like the Affordable Care Act.  Rather than dismantling it and replacing it, much of which requires 60 votes in the Senate vs. the 54 held by Republicans), relaxing the discretionary enforcement, some repealing, some modifying or replacing, but when all is said and done, much will also likely remain.”