From a contrarian standpoint, even though Yellen stated that the central bank would show “patience” in raising interest rates, markets reaction has been jittery. While stocks soared as S&P and Dow closing record high on those days, but retracement ensued afterwards. Start of last week, US stock futures dropped, as did Asian stocks, which really shows an ambivalent market, where hawks are jostling for position. Yellen has often shown her concern for a solid and improving US economy, as it has lacked a sense of absolute robustness, allowing for steady wage growth rate, via an improved labor force participation rate and inflation missing its target. Thus, because of the fact that wage growth rate has been anemic, and economic indicators have lacked a stalwart performance, market participants have viewed Fed’s approach as rather “hawkish” and see an interest rate hike as early as March highly plausible, with another ensuing in June. While Yellen’s approach seems rather balanced, with rate hikes resting on a steadily improving economy, U.S. money market futures give a probability of 90% of a rake hike of 0.25% points as early as March. This could create arbitrage opportunities for the US dollar, and give it a boost in the short term. The stock market, which generally has a direct correlation with a strong dollar, may also inch forward for now. Conversely, looking at the macro-economic implications burden of interest rate hike would be borne by industrial and domestic consumers, which is counterproductive. Thus while there would be an uptick in the financial market, it is unlikely that long term bodes well for the US economy.
What needs ascertaining is whether the US economy will reach a tipping point, with the term structure bias, not in favor of continued economic expansion. For example, the yield on 10 year Treasury note has jumped by 2.583% in the overnight trade, highest since December 20th, and the 2 year Treasury note, which delineates short-term hike and inflation expectations, rose the furthest since 2009 to 1.378%. The negative bias on the term structure is steady showing that economic slowdown will be imminent. The CME factors in a 90% probability of a 25-basis hike in a week’s time and this sets up a precedent for further slowdown.
There are also apprehensions that Trump may not be able to push through his spending plans, and this is phasing out the possibility for him to enact a policy, which would reflect in his next year agenda. Without a robust fiscal spending policy in place, it seems unlikely that US economy would rid itself out of the clutches of a slowdown. It still seems that the Trump would have the last laugh, jeering, “I told you so,” if the economy were to slowdown in case of a hike. Thus, he has to be affirmative on which side to take, because the debate on whether or not to raise interest rates, has assumed a political dimension because the FED stands to lose credibility if it stays pat when job markets have remained solid. Trump also accused Yellen when she was not raising interest rates that could be a market booster but surely counterproductive over the long haul. For example, investment sentiment seemed buoyed with Trump’s plan to reduce taxes, regulation and increasing spending on infrastructure making which does make a solid case for a hike!