Fridays solid NFP print at 228k and wage growth 2.5% y/y, in our view, cements a FOMC 25bp rate hike this week. US economic activity continues to outpace the markets and Feds expectations. Recent Fed communication indicates that hike was coming if the data and financial backdrop remained supportive. This is clearly the case. The market has fully priced in the rate hike with fed fund futures at 98% for a 25bp raise.
Current pricing suggests that the market focus will be on the Committee’s economic and rates projection. At the November FOMC meeting, the committee upgraded assessment of economic activity to “solid”. Since then data has further surprised to the upside. 3Q GDP data, which was already strong, was upgraded. Following payrolls sharp contraction post-hurricane unemployment rate has fallen to 4.1% well below the fed own median estimate of 4.6%.
Inflation data was marginally higher following trend developing in the 2H. Finally, consumer spending, income and production all indicate stronger upwards momentum. If the US needed any more stimulus the increased likelihood for tax reform has risen significantly. The corporate tax cut is likely have the most immediate and positive effect on economic activity estimated adding 0.5% to GDP in 2018. We suspect it is probable that a majority of FOMC participants will increase their GDP forecasts for 2017 and 2018. However, shifting the “dots” form 3 to 4 would be seen as an extremely hawkish signal.
We could get a few of the hawkish members to add hike in 2018 but this would not shift the median view. Our base scenario is marginally on three hike but we are assigning a high probably that and additional hike is added on either in end 2018 or early 2019. Should we see another dot show up the repricing would clearly benefit the USD, which remains on the softer side verse G10 currencies.
Our favorite trade would be given a shift in front end yields would be long USDCHF, which is highly rate sensitive considering the is SNB unlikely to move in 2018.
From an administration standpoint, this will be Chair Yellen’s last meeting and press conference. However, we don’t see that a meaningfully shifting the course of events (ie no event risk).
As with past transitions, Yellen is unlikely to disrupt the Fed current path prior to a handover to Jerome Powell.