FOMC Preview, March 14, 2017

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FOMC Preview

Federal Open Market CommitteeDespite the near-universal expectation of a 25-basis-point rate hike at tomorrow’s FOMC meeting, this meeting contains a lot of very important unknowns regarding the pace of future rate hikes. As such, this meeting is a real, legitimate risk to stocks.

Get our full FOMC preview and all the analysis you need to stay ahead of the market with the Sevens Report. In your inbox by 7am, read it in 7 minutes or less.

It is not an exaggeration to say this Fed meeting could reflect a paradigm shift in the Fed, where the Fed actually gets serious about normalizing policy and interest rates.

Very Hawkish If: 1) The Fed hikes rates 25 bps, 2) The median “dots” show four rate hikes in 2017 and 3) The median dots show four rate hikes in 2018 (currently the dots show just three for both years).

Hawkish If: 1) The Fed hikes rates 25 bps, and 2) The median dots show four rate hikes in 2017 or 2018, but not both years.

Likely Market Reaction:  Restricted for subscribers. Get this data with your free trial of the Sevens Report.

ETFs to Outperform:

Inverse bonds (TBT/TBF/PST), financials (XLF), banks (maybe, but that depends on the shape of the yield curve), TIPS-related bond ETFs (VTIP). ETFs to Underperform: Utilities (XLU), REITs (VNQ) (both interest rate plays), commodity ETFs (DBC), basic materials (XLB), energy (XLE), gold (GLD, GDX).

Meets Expectations If: The Fed hikes rates 25 basis points but the dots don’t shift in either year (i.e. the median dots still show three rate hikes in 2017 or 2018).

Likely Market Reaction:  Restricted for subscribers. Get this data with your free trial of the Sevens Report.

Dovish If: The Fed does not hike rates (this would frankly be a shocking surprise given recent Fed rhetoric). Likely Market Reaction: Stocks, gold and other commodities sharply higher (at least initially). Treasury yields and the dollar sharply lower.

Wildcard to Watch:

The Fed’s Balance Sheet. This is a bit of a confusing topic, but you’re going to be reading a lot more about this in the coming weeks, so I want to cover it now so everyone has proper context. With the Fed hiking rates, it’s quickly approaching the time when the Fed will have to naturally reduce its balance sheet. And what I and others mean by that is the Fed will have to stop reinvesting the principal that it receives when the Treasuries it owns are redeemed.

The reason this is important is because it could put further pressure on the bond market. If the Fed gets $100 million in short-term Treasuries redeemed, right now it simply buys $100 million worth of new Treasuries. But, if the Fed were to stop reinvestment, that $100 million wouldn’t go back into the bond market, removing a source of demand.

The point is that when the Fed stops reinvesting principal, that will be potentially bond negative/yield positive, and that process needs to be managed very carefully considering the size of the Fed’s balance sheet ($2.4 trillion in Treasuries, $1.7 trillion in mortgage backed securities).

Bottom line, if the Fed changes the language on the reinvestment of the balance sheet (it’ll be in the second to last paragraph in the FOMC statement) then that would be incrementally hawkish, and we’d likely see bond yields and the dollar higher, and stocks lower. The market is not at all expecting any impending balance sheet changes from the Fed this soon in 2017.

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Doctor Copper Confirming Equity Strength, For Now.

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Copper

Copper futures are continuing to hold their post-election gains and for now, confirming the strength in stocks based on the thesis of robust economic growth and increased infrastructure spending by the new administration.

 

“Just Right” Jobs Report & This Week’s Numbers. March 13, 2017

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This is an excerpt from today’s Sevens Report. Sign up for your free trial for clear, easy-to-digest information on stocks, bonds, commodities, currencies, and economic data, in your inbox by 7am each morning.

Last Week:

The only material economic report last week was the jobs report, and it confirmed that the Fed will hike rates this Wednesday. Internationally, the ECB was very slightly hawkish in tone, although it has no plans to further curtail its QE program. As such, the hawkish tone was taken more as an endorsement of accelerating growth and inflation momentum, and European stocks (HEDJ) rallied on the news.

Looking at the jobs report, it was at the higher end of our “Just Right” range, and as such it confirmed a coming rate hike this Wednesday… but it wasn’t so strong that it would cause the Fed or the market to consider four hikes in 2017.

The headline jobs number was a solid beat at 253k vs. (E) 195k, and revisions to January and December were positive by 9k. The unemployment rate dropped to 4.7% vs. (E) 4.8%, but that also came on lower labor participation (so it’s not a fully virtuous drop). However, U-6, which is the better measure of employment as it counts underemployment, fell to 9.2% from 9.4%—matching a multi-year low it set back in December. Point being, we can quibble over the 4.7% unemployment rate, but in total, measures of the jobs market are signaling the economy is at full employment. Wages also rose 0.2% in February vs. (E) 0.3%, and the y-o-y gain increased slightly to 2.8%, or just below our “Too Hot” mark of 2.9%.

Bottom line, it was a Goldilocks report (the second in a row), and stocks rightly rallied, as again it signaled a very strong jobs market (at least in terms of employment) and rising wages. Still, none of the numbers were so high that it should make the Fed materially more hawkish. Bigger picture, economic data continues to broadly sup-port the markets while the policy outlook in Washington grows more dim seemingly each week. The new variable is the Fed, however, and if rates rise too fast in 2017 (which we think they might) that could increase the risk to stocks. For the first time in 11 years, the pace of rate increases is an important variable for stocks.

Looking internationally, the ECB was very slightly hawkish in tone during last week’s meeting, but that’s only because the ECB cited improvement in growth and inflation data (both of which were stock positive). So, in some ways the ECB finds itself in a similar position to the Fed several years ago (late- 2014/early 2015) when it was winding down QE very gradually into a slowly accelerating economy. That environment is positive for stocks, so despite reports of the ECB turning more hawkish, policy will remain accommodative for a very long time, and we remain bullish European stocks.

This Week: 

Wednesday is the most important day this week, as we not only get the FOMC decision, but there also will be very important releases on inflation and growth. Again, the critical context for all of this is whether the Fed and the data point to more than three hikes in 2017, a situation that is not priced into stocks, the dollar or yields.

Starting first with the FOMC meeting, we will give our “FOMC Preview” in tomorrow’s subscriber version of the Sevens Report, but while a 25-basis-point rate hike is widely expected, the real key to this meeting is whether the FOMC increases the number of expected rate hikes (i.e. the “dots”) to four from three. That’s the hawkish variable to watch for Wednesday, because that could hit stocks and bonds.

Consumer Spending is Major Catalyst

Consumer spending remains the biggest driver of economic growth, and that needs to continue if we’re to see a broad acceleration.

In addition to the Fed decision Wednesday, we get two important February economic numbers: CPI and Retail Sales. CPI has been slowly creeping higher, and if that continues it will increase the chances of four rate hikes this year (regardless of what the FOMC says). Meanwhile, after big growth in Q3/Q4 2016, retail sales have cooled in 2017, and a resumption of that uptrend will be welcomed by stocks (strong economic data is needed to support this market in the face of a growing mess in Washington and higher rates). Consumer spending remains the biggest driver of economic growth, and that needs to continue if we’re to see a broad acceleration.

Finally, I’ll talk more about this in tomorrow’s full edition of the Sevens Report, but there has been a growing gulf between economic data that’s based on surveys (i.e. the PMIs) and actual, hard data. People in the media are calling it “soft vs. hard” economic data, but here’s the issue. While survey data has been surging to multi-year highs, actual economic data really isn’t moving that much. That’s a potential problem for obvious reasons. Actual hard data—retail sales and industrial production (out Friday), need to start to match this survey data, otherwise that gap will widen.

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What’s Next for the Dollar? (Chart)

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Dollar index futures finally broke out of a multi-year trading range after the election, but may have potentially just found a new set of trading boundaries between 100 and 104. From here, it all depends on the Fed.

 

What to Expect in Tomorrow’s Jobs Report. March 9, 2017

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Jobs Report Preview: For notable releases like tomorrow’s jobs report, the Sevens Report offers a “Goldilocks” outlook to give a few different scenarios: too hot, too cold, and just right.

This gives our subscribers clear talking points to explain the importance of the report to clients and prospects clearly and without a lot of jargon. As always, the Sevens Report is designed to help you cut through the noise and understand what’s truly driving markets—all in seven minutes or less and in your inbox by 7am each morning. Sign up for your free 2-week trial today and see the difference this report can make for you.

Wednesday’s ADP Jobs Report clearly put upward pressure on expectations for tomorrow’s government report. And, there’s good reason for that. Over the past five months, the ADP report has been within 10k jobs of the official jobs report (the one outlier was November, when ADP was 50k over the actual jobs report). So, yesterday’s 298k jobs blowout implies a big number tomorrow.

Given that, the major issue for tomorrow’s jobs report is simple: Will it cause the Fed to consider more than three rate hikes in 2017? If the answer is “yes,” than that’s a headwind on stocks. If the answer is “no,” then it shouldn’t derail the rally.

Getting a bit more specific, the only reason the dollar is still generally stuck at resistance at 102 (and below the recent high at 103), and the 10-year yield is still below 2.60% is because the market assumes that the Fed will still only hike rates three times this year.

If that assumption gets called into doubt via a very strong jobs and wage number tomorrow, we will see the Dollar Index likely surge through 103 and the 10-year yield bust to new highs above 2.60%, and then they will begin to exert at least some headwind on stocks.

So, tomorrow’s jobs report is potentially the most important jobs number in years, as it has the ability to fundamentally alter the market’s perception of just how “gradual” the Fed will be in hiking rates.

“Too Hot” Scenario (Potential for More than Three Rate Hikes in 2017)

  • >250k Job Adds, < 4.9% Unemployment, > 2.9% YOY wage increase. A number this hot would likely ignite the debate about whether the Fed will hike more than three times this year (or more than 75 basis points if the Fed hikes 50 in one meeting). Likely Market Reaction: Restricted for subscribers: Access today by signing up for your free 2-week trial.

“Just Right” Scenario (A March Rate Hike Is A Guarantee, But Three Hikes for 2017 Remain the Expectation)

  • 125k–250k Job Adds, > 5.0% Unemployment Rate, 2.5%-2.8% YOY wage increase. This is the best-case scenario for stocks, as it would imply still-stable job growth, but not materially increase the chances for more than three rate hikes in 2017. This is the most positive outcome for stocks. Likely Market Reaction: Restricted for subscribers: Access today by signing up for your free 2-week trial.

“Too Cold” Scenario (A March Hike Becomes in Doubt)

  • < 125k Job Adds. This would be dovish, and while the fallout would be less than previous months given the market’s focus on future growth, the bottom line is bad economic data still isn’t good for stocks. Dovish isn’t bullish any-more. Likely Market Reaction: Restricted for subscribers: Access today by signing up for your free 2-week trial.

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Oil’s Huge Selloff: Chart

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After trending sideways for roughly two-and-a-half months, oil prices finally broke down out of their recent trading ranges yesterday, and in a big way with 5% drops in both WTI and Brent.

 

How Does Trump’s Approval Rating Impact The Stock Market? March 8, 2017

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Leading Indicator Update: Showing Signs of Fatigue

An excerpt from today’s Sevens Report… Skip the jargon, arcane details and drab statistics, and get the simple analysis that will improve your performance.

At the start of the year, I said that beyond the normal economic data and fund flow data, we’ll be watching two other specific leading indicators:

  • Trump’s approval rating, and the
  • Semiconductor Index.

As a refresher, we watch Trump’s approval rating because it is an imperfect, but still effective, measure of political capital.

Earlier this year, we said that if his approval rating dips in the weeks and months following Inauguration Day, that won’t be a positive sign for corporate tax cuts (i.e. it will be stock negative). Conversely, if his approval ratings rise following his inauguration, the chances of tax reform will rise (i.e. it will be stock positive).

Turning to the Semiconductor Index (see chart on Pg. 1), we view semiconductors as a destination for incremental capital that comes off the sidelines or out of bonds.

It’s our proxy for money flows, or “chasing” into the US markets.

That reasoning here is based on watching the price action in semis and observing that they handily outperformed post election (implying they were a destination for capital coming off the sidelines), and we continue to believe that is the case.

LI #1: Trump’s Approval Rating Updated. The outlook here hasn’t been that positive, and the movement in the approval rating anecdotally confirms our opinion that the market remains too optimistic regarding corporate tax cuts in 2017.

Why is the president’s approval rating a leading indicator?

From a broad standpoint, Trump’s approve/disapprove gap has gotten worse since the inauguration, and we think that represents a slight erosion of political capital.

Last week, we saw a slight bounce following his speech to Congress, but the numbers look to be rolling over again.

I am particularly focused on his raw approval rating numbers (as opposed to just the spread between approve/disapprove). So, while the spread between approve/disapprove has gotten worse, the reason this leading indicator isn’t flashing negative for me is because Trump’s raw approval rating is still about the same as it’s been since the inauguration (about 44%).

However, if that raw number were to drop below 40%, I would view that as a material negative for pro-growth policies… and a potential negative for stocks.

LI #2: Semiconductor Index Updated. The Philadelphia Semiconductor Index, our loose proxy for incremental money flows out of bonds/other assets and into stocks, has until recently confirmed the 2017 rally.

The SOX rallied 9% from the first of the year till February 22, at which point the index stalled, and it’s traded side-way for nearly two weeks.

Going forward, support at 955.11 now is an important level to watch, as a break of that level would constitute a “lower low” on the charts.

Below that, support at the 20-day moving average at 947.25 has supported this index three times over the past few months. So, that also will be an important level to watch.

Bottom Line

Neither of these leading indicators have sent a non-confirmation signal of the rally at this point. Yet after confirming the rally earlier this year, both of these leading indicators are starting to wobble.

Again, we’ll be watching 40 in Trump’s approval rating and 955 and 947 in the SOX. If those levels are broken that will likely prompt us to become more defensive near term for stocks.

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Senate Math Primer. March 7, 2017

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Senate Math Primer from the Sevens Report: One of the easiest ways to cut through the seemingly unending amount of political noise in the markets is to focus on the fact that there are only two important questions that need to be answered.

  1. Will Republicans agree on border adjustments and a corporate tax cut?
  2. Can that plan get approved in the Senate?
Senate in Session

Republicans have a simple 52 to 48 majority—but that’s not really that powerful.

We’ve already covered the first question from multiple angles in the full subscriber edition of the Sevens Report, but I think the second question is just as important.

In fact, part of the reason I’m covering this is because I get the sense that a lot of people think that once a plan has general Republican support it will automatically become law, because Republicans “control” the House, Senate and the presidency.

While the first and the last are truly under control from Republican leadership, the Senate is anything but.

Looking at the math, as mentioned yesterday, Republicans have a simple 52 to 48 majority—but that’s not really that powerful.

First, it’s well short of a filibuster-proof 60-person majority, and there’s zero chance eight Democrats will break with Republicans on Obamacare or corporate tax cuts.

That’s why both those issues have to be passed via a budget process called “reconciliation.” Reconciliation only requires a simple majority, so 52 to 48 would work.

But, it gets more complicated than that.

First, to say Republicans have a hard 52 votes on any issue is an overstatement. Senator Susan Collins of Maine (technically a Republican) acts much more like an independent. The same can be said for Alaska Senator Murkowski (she’s taking a hard line against supporting an Obamacare repeal that rolls back Medicaid expansion).

Then, there are Senators McCain and Graham. Both are solid Republican votes, but I think it’s fair to say they despise President Trump for multiple reasons. So while it’s unlikely they’d derail passage of Obamacare repeal/replace or tax cuts, they are going to be tough “gets.”

Finally, Rand Paul is more Libertarian than Republican, and he (and others) will have a hard line approach to any tax cuts that might increase the deficit.

Bottom line, while Republicans “control” the legislative and executive branches of government, the Senate is still a bottleneck in the legislative process, and getting Obamacare repeal/replace through the Senate by Memorial Day will be a tough task—never mind corporate tax reform by the August recess (remember, there aren’t even hearings scheduled for the Supreme Court nominee yet).

Again, I’m not trying to throw cold water on this rally, or the optimism fueling it. I’m just trying to keep everyone focused on facts, and the outlook for passage of major reforms through the Senate remains dicey at best.

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How Many Rate Hikes in 2017? Last Week and This Week: March 5, 2017

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The Economics excerpt from today’s Sevens Report, which focuses on the most important financial news and takeaways for investors, financial advisors, and CPA’s, last week and this week.

Even uber-dove Lael Brainard supported potentially hiking in March.

Last Week:

The major takeaway from the economic data and Fed speak last week is that because of continued strong data and hawkish Fed speak, a March rate hike now is expected by the markets. Probability (according to Fed Fund futures) of a rate hike on March 15 rose from just over 20% two weeks ago, to over 70% at the end of this week… and that was a legitimate surprise for markets.

The reason that change didn’t cause a pullback in stocks is simple. Economic data last week showed continued acceleration in growth and inflation, and as such that helped cushion the blow from the increased rate hike expectations.

To that point, there were three big numbers from last week and they all beat estimates. February ISM Manufacturing PMI rose to 57.7 vs. (E) 56.4, February ISM Non Manufacturing PMI rose to 57.6 vs. (E) 56.5. And, the core PCE Price Index (the Fed’s preferred measure of inflation) rose 0.3% in February, the biggest monthly increase since January 2016. While the core PCE Price Index rose 1.7% yoy, same as January, the headline PCE Price Index rose 1.9% yoy, just below the Fed’s 2% target and the highest level since February 2013!

Not every economic data point was strong last week (Pending Home Sales missed estimates as did Core Durable Goods. And, headline revised Q1 GDP was a touch light at 1.9% vs. (E) 2.1%). Still, the good data handily outweighed the bad data.

Bigger picture, it’s hard to understate how important continued good economic data has been for markets in 2017. Strong data has helped buy Washington more time on corporate tax cuts, and now it’s helping to cushion the blow from a potentially more hawkish Fed. Strong economic data continues to be the unsung hero of the 2017 stock rally, and it needs to continue given the increasingly bleak policy outlook, and potentially a more hawkish Fed. Frankly, watching and correctly interpreting economic data hasn’t been this important in years.

Looking at Fed speak from last week, it was almost universally hawkish. Clearly the Fed is trying to pave the road for a March rate hike. Fed officials Williams, Dudley and Powell all signaled that a rate hike could come in March, and even uber-dove Lael Brainard supported potentially hiking in March.
Then, as if there was any doubt left by the end of last week, on Friday Fed Chair Yellen basically said that if the jobs report is in line, the Fed is hiking rates (her exact words were more general, and a bit more eloquent, but that was her point).

Bottom line, the Fed appears to be sticking to its promise of three rate hikes in 2017, with the first likely coming in 10 days.

This Week:

Are Janet Yellen and the other members of the Fed supporting more rate hikes in 2017?

Jobs reports are always important economic releases but due to the potential for a March rate hike, this jobs report is even more important than normal because it will decide whether we get a hike next Wednesday.

As usual, it’s jobs week, so that means we will get the ADP report on Wednesday, weekly jobless claims on Thursday (which continue to hit levels last seen since the 1970s), and the official jobs report Friday.

I’ll do my normal “Goldilocks” jobs preview later this week, but the bottom line is that as long as this jobs re-port remains firm, the Fed will hike rates next week.

Outside of the jobs report, it’s actually a pretty quiet week, economically speaking.

In the US, the only other notable report is Productivity (out Wednesday). Low worker productivity has been a major downward influence on inflation, but it’s shown signs of ticking higher lately. A continuation of that trend will be slightly hawkish. Finally, looking internationally, China will be in focus as we get Trade Balance (Tuesday) and CPI/PPI Wednesday.

Data from China has been consistently decent (including last week’s February manufacturing and composite PMIs), so it’ll be a big surprise if the data suddenly turns south, but China remains a macro area to watch as any hints of a slowdown will make waves for global markets.

Bottom line, this week really is all about the jobs report. If it’s close to in line, the Fed will hike next Wednesday. And, if it’s hotter than expected, get ready for talk about more than three hikes this year (and that idea is a risk to stocks).

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If A Rate Hike Is Expected, Why Aren’t Rates and the Dollar Higher? March 3, 2017

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Get the simple talking points you need to impress clients and prospects from the Sevens Report. Here is an excerpt from today’s full report.

If A Rate Hike Is Expected, Why Aren’t Rates and the Dollar Higher? 

If a rate hike is expected, why isn’t the dollar index higher?

That’s a fair question to ask, given two weeks ago there was no expectation of a May rate hike. Then, a week ago, there was no expectation of a March rate hike. Now, a March hike is fully expected.

Yet despite that relatively quick shift, as mentioned the Dollar Index still isn’t materially above 102, and still not close to the recent 103 high. Meanwhile, the 10-year yield is still decently below 2.60%.

The reasons we haven’t seen greater rallies in the dollar or yields are twofold.

First, a rate hike is not a foregone conclusion because of the jobs report next Friday. If it’s disappointing then a May hike makes more sense.

Second, the market still doesn’t believe the Fed is materially more hawkish. So, even if the Fed hikes now, the market still expects just three hikes the remainder of the year, which is what the Fed said in December.

The point is, the currency and bond markets still haven’t fully priced in a March hike yet, nor have they accepted the existence of a “hawkish.” Fed. However, if that jobs number is strong I believe we’ll see further upside in the dollar and yields.

But the big jumps in both will come when the market realizes the Fed is more hawkish than it currently expects, and that likely won’t happen until we see more inflation or proof of actual fiscal stimulus.

Regardless, barring an economic set back the trend higher in the dollar and rates is close to resuming, and investors should be positioned accordingly.

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