The Fed minutes from the 26th July meeting, released yesterday evening, were taken as dovish by the market; as the members expressed some concerns over the inflation outlook. The minutes highlighted that while many participants felt much of the recent decline in inflation had reflected ‘idiosyncratic factors’ many saw ‘some likelihood’ that inflation may remain below the 2% target for longer than expected. Some members stressed that there was room to be patient while ‘some others’ were concerned the labour market had already reached full employment, and a delay could lead to ‘an intensification of financial stability risks’. In terms of the balance sheet reduction plan, ‘several’ voters wanted to announce a plan at the current meeting but ‘most preferred to defer that decision until an upcoming meeting’.
In essence, post the minutes, the market now prices a December rate hike at around 40% with expectations for an announcement of the start of the tapering of reinvestment announced in September and enacted during the following few months.
We broadly concur with the balance sheet view and also with the probability of a rate hike in December; however, we remain at odds with the market regarding expected rate hikes in 2018 as we remain of the view rates will remain lower than consensus and the danger is that the hikes already in place as well as the balance sheet tapering further curtail growth in an economy which is showing fragility in certain sectors.
The other news yesterday was of course President Trump who disbanded the Manufacturing Council and the Strategy and Policy Council. Both these were set up by Trump with the council's membership made up by CEOs from the dominant American companies. But after a further 3 resigned yesterday, making five in three days, Mr Trump disbanded the councils to stop further embarrassment from the only eight remaining members’ resignations.
If we look at the US Treasury market and go back to the pre-Trump election, on say 31 October 2016, the long bond had a 125 price on it. Trump's election which caused a spike in longer dated rates on fears of trillion dollar infrastructure spending initiatives and massive corporate tax cuts, saw the bond sell off around 14 points in price. The bond is still around six points in price lower than at October’s month end. This seems at odds to us as even after the realisation that the current administration is going to struggle to enact anything near the election promises the US long bond remains one of the cheapest assets on a relative basis with a yield around 2.81%. As an idea long dated Pemex, the Mexican integrated Oil company is around 5 points higher in price over the same period.
Old Chinese proverb ‘no wall is too high to climb’, sorry President Trump I couldn’t resist.