Quarterly GDP growth was downgraded from 0.3% to 0.2% in Q1, though we suspect that noise in the data is exaggerating the extent of the slowdown between Q4 2016 and Q1 2017. A stronger outturn for services output in March suggests the economy carried greater momentum into Q2 than previously thought. But while we could see a modest bounce in Q2, the bigger picture remains one of weaker growth in 2017.
The minutes from the May 2-3 FOMC meeting strongly support our view that the FOMC will raise interest rates and announce its balance sheet normalization plans at the upcoming June 13-14 FOMC meeting. In line with our expectation, "nearly all" Fed officials agreed it is "likely appropriate" to begin reducing the balance sheet later this year.
Consistent with a gradual implementation of a "passive and predictable" unwind of the balance sheet, policy makers are considering a "preannounced schedule of gradually increasing caps to limit the amount of securities that could run off" the balance sheet in any given month. We had assumed in our base case scenario that the FOMC would allow 50% to roll-off in the first year.
Existing home sales declined 2.3% in April to a rate of 5.57 million, but continue to trend up. Tight inventories and high prices remain major constraints with the supply of homes for sale declining 9.0% y/y in April, and home price inflation up 6.0%.
its first budget blueprint,
Administration promises to balance the federal budget over the next ten year
via a mixture of severe spending cuts, totalling $3.6 trillion, and a very
optimistic growth outlook.
New home sales declined 11.4% in April to a SAAR of 569,000. There were large upward revisions to sales in the first quarter. Despite the decline in April, strong labor market conditions, still-low mortgage rates and increases in supply point to gains in new home sales in the months ahead.
When the Fed reduces the amount of Treasury debt it reinvests, the Treasury will have to increase its borrowing from the public by an equivalent amount, and the average maturity of debt outstanding will rise. The 10-year Treasury note term premium, which has been greatly compressed by the Fed's Treasury purchases, should normalize to moderately higher levels as the Fed normalizes the size of its balance sheet and short-term interest rates. All of the above should underpin a moderate rise in 10-year nominal yields over the coming quarters/years.
We forecast that Treasury coupon issuance will need to rise by approximately $500 billion over the next three years as the Fed shrinks its balance sheet. By 2021, the average maturity of outstanding debt would gradually increase from six years to about 6.25 years—the longest duration in more than four decades.
However, the Fed's well-telegraphed intention for a "passive and predictable" unwind of the balance sheet should avert another "taper tantrum." Indeed, we expect the term premium to widen gradually and moderately over the coming years. By 2021, the Fed funds rate should reach its neutral rate of 2.9%, and the 10-year Treasury note yield would rise to 3.5%.