Friday March 3

Stocks were little changed to finish off the week as Janet Yellen came across as hawkish. The S&P 500 rose 0.05% to 2,383 and the Dow Jones added 0.01% to 21,005. Over the course of the week the S&P 500 was 0.7% higher and the Dow was 0.7% higher. Economic data today showed that the PMI Services Index fell to 53.8 which is below the prior reading of 55.6. The ISM non-manufacturing index rose to 56.6 which was above the consensus of 56.5. Jeffrey Lacker of the Richmond Fed suggested that the Fed should act soon in order to prevent inflation from getting out of their control. Hawkish comments also from Jerome Powell, Stanley Fischer and Janet Yellen also capped off a very busy week of Fed speak. Over the course of the week traders shifted their expectations about a rate hike this month. On that backdrop the two year Treasury yield rose 1bp to 1.31%. The ten year Treasury yield was unchanged at 2.49%. Accordingly the yield curve bear flattened to 1.18%. Over the course of the week the ten year Treasury yield was 19bp higher after multiple hawkish comments. The dollar weakened on the day in spite of the comments from the Fed. USD fell 1% against EUR to $1.0616. USD fell 0.4% against JPY to Y113.96. USD fell 0.2% against GBP to $1.2292. WTI rose 1.2% as the dollar took a break to $53.22. Brent rose 1.3% to $55.80. The VIX continues to fall and finished the week at 10.94.

Inflation has been making a comeback over the last month or so around the globe which is a big contrast to the environment just last year. Last year economies around the globe including the entire eurozone, Japan, and the United States were plagued by low inflation and even deflation in some cases. However now a wave of inflationary pressures seems to be sweeping around the world as PPI, CPI, and import price indices everywhere are showing upward trends. One of the factors that has been supporting this trend is rising oil prices which have doubled since the start of last year driving up year over year inflation numbers. Economists and central bankers hope that as the effects of oil are reduced in inflation numbers going forward tightening labor markets will pick up where oil left off. Inflation expectations in the U.S., Germany, and Japan have been creeping up on an upward trend to 2%, 1.2% and 0.5% respectively. Central bankers in Japan expect inflation to hit 1% within a year after many years of deflation. That comes as a weaker Japanese yen would increase import prices. Japan today pulled out of deflation for the first time in more than a year according to CPI data. Central banks that were battling with deflation may now start to consider pulling back from zero interest rate policies and substantial quantitative easing programs. PPI and CPI indices are also on the rise in China which given its position in the global economy exports inflation around the world.

Comments made by Janet Yellen today suggest the Fed is on track to raise interest rates this month barring unforeseen circumstances and economic data downside surprises. She said that it would be “appropriate” to raise interest rates at the March 14-15 meeting if unemployment and inflation continue to shift in line with expectations. Given that in the absence of a downside surprise for next Friday’s NFP report traders are expecting higher rates the following week. In just a few days the odds of higher rates this month have shot up from below 40% to nearly 100% currently. Fed funds futures are now pricing in 2.5 rate hikes this year from the FOMC which is close to their estimation of 3 rate hikes they made in December. Janet Yellen is typically dovish so when she does come across as in favor of higher rates investors pay attention. Investors heard several members of the FOMC loud and clear this week. That would bring the Fed funds rate to 0.75% – 1.0%. It is also important to note that she doesn’t think the Fed is falling behind the curve as some analysts have suggested could happen as they wait too long to raise interest rates. Stanley Fischer also pointed out that economic indicators have nearly unanimously come in trending positively over the last three months. Stock prices are at records, IG and HY spreads are at the tightest level in more than three years and some analysts are now of the belief that the Fed should act now to prevent too much speculative activity.

The Mexican peso appreciated 2.5% today to MXN 19.5118 after investors take the view that the U.S. won’t take as hardline of a stance on the country as it initially seemed. Wilbur Ross who was confirmed as commerce secretary inferred that he might be willing to take a conciliatory and cooperative stance with Mexico. Referring to the Tequila crisis in 1994 he spoke of the virtues of having a stable dollar-peso exchange rate and said he would help think of a mechanism to promote that. That suggests cooperation with Mexican policymakers. He is in favor of revamping Nafta but is in favor of doing so in a way that would benefit the Mexican peso. Since the election the central bank in Mexico has spent $20bn trying to prop up its currency. Mexican officials could be behind revamping Nafta in a way that is a win-win for both parties. Ross also suggested that he was not in favor of pulling out of the World Trade Organization.

Friday March 3

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