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FOMC Preview and Projections plus the Wildcard to Watch, June 13, 2017

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The Fed meeting is more important than any other this year, for the simple reason that it could either exacerbate the glaring discrepancy between stocks and bond yields (which would be negative for risk assets medium term), or it could help close the gap (which would be positive for risk assets).

Specifically, the bond market has quietly been pricing in the expectation of a “dovish hike” for this meeting via the decline in yields. That “Dovish Hike” means the Fed does hike rates 25 basis points, but makes the statement dovish enough that it doesn’t cause longer-dated yields (i.e. 10- and 30-year Treasuries) to rise. If the Fed executes on that expectation, then we will see the 10-year yield dip and likely test the 2017 lows of 2.14%, and again that is a problem for stocks over the medium/ longer term.

Looking at the actual meeting itself, whether it meets expectations, is dovish, or is hawkish, will depend not only on the rate hike, but also the inflation commentary and any guidance regarding “normalization” of the balance sheet.

What’s Expected: A Dovish Hike. Probability (this is just my best guess) About 70%. Rates: It would be a pretty big shock if the Fed didn’t hike rates tomorrow, so a 25-basis-point hike to 1.25% is universally expected. Statement: In paragraph one, the Fed should include some additional soft language regarding inflation, noting that it’s been soft for a few months. However (and this is important), the Fed should still attribute sluggish inflation to “transitory factors,” implying Fed members are still confident they will hit their 2% inflation goal. Dots: No change to the 2017 dots (so, still showing three hikes as the median expectation). Likely Market Reaction: Withheld for Sevens Report subscribers. Unlock by starting your free trial today.

Dovish If: No Hike or a Very Dovish Hike. Probability (again, my best guess) About 10%. Rates: It’s widely expected that Fed will hike rates, but there’s always a possibility of a surprise. More likely, the Fed will hike 25 bps and accompany it with a very dovish statement. Statement: The Fed changes the characterization of risks from “balanced” to “tilted to the downside,” or some similar commentary, thereby signaling rate hikes are off the table again. This is a very unlikely, but possible change. More likely is the Fed adding considerable language regarding concerns about lower inflation. Dots: A reduction of the dots to reflect just two rate hikes in 2017. Likely Market Reaction: Withheld for Sevens Report subscribers. Unlock by starting your free trial today.

Hawkish If: We get a regular hike, not a “Dovish” Hike. Probability About 20%. Rates: The Fed Hikes Rates 25 basis points. Statement: The Fed does not add softer language regarding growth or inflation in the first paragraph, and instead just largely reprints the May statement, which was dismissive of the recent dip in inflation and growth. Dots: The dots remain the same or even increase one rate hike in 2017 (this is unlikely, but possible). Likely Market Reaction: Withheld for Sevens Report subscribers. Unlock by starting your free trial today.

Wild Card to Watch: The Fed Balance Sheet

The market fully expects the Fed to elaborate on when and how it intends to reduce its balance sheet (i.e. the holdings of Treasuries it has purchased over the years through the QE program).

I covered why the balance sheet is important back in April (a link to that report is here) but the bottom line is that when and how the Fed begins to reduce its balance sheet (the term “normalize” is just Fed speak for “reduce Treasury holdings”) could be a substantially hawkish influence on the bond market, regardless of rate hikes.

Specifically for tomorrow, the key detail the market will be looking for is at what level of interest rates does the Fed begin to reduce its Treasury holdings. The number to watch here is 1.5%. It’s widely expected that at 1.5% Fed funds, the Fed will begin to reduce its balance sheet. If we get one more rate hike this year, then that puts balance sheet reduction starting in early 2018 (likely March).

For a simple reference, if the Fed statement or Yellen at her press conference reveals the Fed will reduce holdings before 1.5%, that will be hawkish. If it’s revealed that the Fed will reduce holdings after rates hike 1.5% that will be dovish.

Bottom Line

This Fed meeting is likely the most important of the year (so far), not just because we will get updated guidance on expected rate hikes and the balance sheet, but also because it comes at a time when we are at a tipping point for bond yields (if they go much lower and the yield curve flattens, more people will start talking recession risk). We also are potentially seeing a shift in stock sector leadership (from defensives/income to cyclicals/ banks), so understanding what the Fed decision means for rates will be critically important going forward. You’ll have our full analysis, along with practical takeaways, first thing Thursday morning.

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Weekly Market Cheat Sheet, June 12, 2017

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Weekly Market Cheat Sheet

Last Week in Review:

There were only a few economic releases last week and the Fed circuit was silent ahead of this week’s Fed events.

The headline of the ISM Non-Manufacturing PMI was largely in line with expectations at 56.9 for May, and the details matched as well. The one outlier was a sharp dip in the prices category, which fell to 49.2 from 57.6. It was the first sub-50 reading in 13 months. And while the one number by itself is not very alarming, pairing it with other soft price data of late, including the weak unit labor cost on Monday, inflation data is beginning to gain some attention. For now, it is just something to monitor and will not have a material effect on Fed policy yet.

Looking overseas, the EBC decision was the big event last week. As expected, rates were left unchanged and there were no changes in the QE program. The ECB changed their risk assessment to “balanced” and also removed the potential for lower interest rates going forward. Overall, the meeting was anti-climactic as a step was taken towards eventually ending QE, but no update on the timeframe was offered.

This Week’s Preview:

Focus will be on central banks this week as the Fed takes center stage Wednesday, the BOE is Thursday and the BOJ is Friday. The Fed will obviously attract the most attention as a rate hike is expected, but the outlook for future policy has grown cloudier. The market will be looking for any clues as to the number of rate hikes remaining in 2017, or whether the committee’s sentiment towards the economy has changed in recent months. We will have our full FOMC Preview in tomorrow’s Report.

As far as economic data goes, CPI and Retail Sales will both be released pre-market ahead of the FOMC on Wednesday (which we will provide a preview for, as always).

Later in the week we get the first look at June data from the Philly Fed Business Outlook Survey and the Empire State Manufacturing Survey as well as Industrial Production data for May. The latter will be important to see if the recent bounce in manufacturing data has continued at all in Q2 or not. Lastly on Friday, Housing Starts data for May will provide the latest update on the housing market.

Overseas, there are some important releases to watch beginning on Tuesday night with Chinese Fixed Asset Investment, Industrial Production, and Retail Sales all due at 10:00 p.m. ET. There are several second-tiered reports that may move market modestly if there are any surprises, but the only other report overseas really worth watching is the Eurozone HICP (their CPI) to see if inflation is firming at all or actually rolling over as some individual European country reports have shown (German CPI was -0.2 vs. E: -0.1% in May).

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Weekly Market Cheat Sheet, May 29, 2017

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Weekly Market Cheat Sheet May 29

Last Week in Review:

Economic data continued to underwhelm last week, and while for now, the lack of strong data isn’t preventing stocks from making incremental new highs. Beyond the short term, if we are going to see a material move higher from here, economic data needs to get better, period.

The two most important reports last week were the May Flash Manufacturing PMI and the April Durable Goods report, and both underwhelmed. The May flash manufacturing PMI dropped to 52.5, the lowest reading since of 2017, while Durable Goods was, as usual, a bit of a misleading number.

The headline on Durable Goods was better than expected at -0.7% vs. (E) -1.0%. We dismiss the headline because it’s massively influenced by the timing of airplane orders. Instead, we focus on New Orders for Non-Defense Capital Goods, Ex- Aircraft. That is the purest look at business spending and investment in the Durable Goods report, and there the results were a disappointment. NDCGXA was flat vs. (E) 0.2% increase while the March data was revised lower (from 0.2% to 0.0%).

Bigger picture, these soft business spending/investment numbers raise the question as to whether all this policy uncertainty regarding corporate taxes (will rates be cut, and what changes will occur with the deductibility of interest, etc.?) is starting to restrain business investment. To be clear, there’s no data that says it is being restrained, yet. However, it is a legitimate concern the longer we go with no clarity on taxes.

The other notable report from last week was the revision of Q1 GDP, and on the whole it was positive. Headline Q1 GDP was increased to 1.2% from 0.7%, and consumer spending (PCE) rose to 0.6% vs. (E) 0.3%. To be clear, that’s still pretty anemic consumer spending… but at least the numbers got a touch better.

Finally, turning to the Fed, the market traded slightly dovish last week after the release of the May FOMC minutes. In particular, worries about whether we’re losing upward momentum on inflation, combined with similar comments from Philly Fed President Harker a week ago, resulted in a slightly dovish move in currencies and bonds. But to be clear, the expectation for a June hike remains very high, and it’ll likely take a very soft core PCE Price Index (out today), and a bad wage number in Friday’s jobs report to put that June hike in doubt.

This Week’s Preview:

With the amount of economic data coming this week, it would be a busy week even if we had five days to absorb it all. So, it will be an especially busy week given we’ve got just four trading days this week.

First, it’s jobs week, so we get the ADP Jobs Report on Thursday (a day later due to Memorial Day), Jobless Claims on Thursday, and the government jobs report on Friday. We will send our standard “Jobs Report Preview” in Thursday’s report. As has been the case for virtually all of 2017, the wage numbers are almost as important as the actual jobs number itself, as signs of further deterioration could lead to a dovish Fed while a strong number could put upward pressure on the expected number of hikes in 2017 (from three to four).

Right behind the jobs report in importance this week is the May final manufacturing PMI, out Thursday. Obviously, with the disappointing flash PMI, a slightly better number this week will help inject a bit more confidence into the state of economic momentum here in the US.

And while the US number is important, the most important manufacturing PMI this week may be China, which comes tonight. Very quietly, Chinese data has been softening, and if we get a surprisingly bad number that could send a macro shock through markets.

Turning to inflation, our focus there will be a bit more acute this week given the FOMC minutes and Harker’s comments from last week. That means that today’s Core PCE Price Index, which is contained in the Personal Income and Outlays report, will be important. If it shows evidence of moving down further from the Fed’s 2.0% yoy target, that will create a dovish response from markets and sink Treasury yields further (which will be a negative for stocks).

Bottom line, the jury is still very much “out” on the current momentum in the US economy. In an absolute sense, data remains “ok,” but we are not seeing the acceleration everyone thought we would when the reflation trade was roaring back in Dec/Jan. If data continues to underwhelm, it will become a headwind on stocks beyond the short term… and again, that’s a point that is very important not to miss. We need better data to make this rally sustainable above 2400.

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Weekly Market Cheat Sheet, May 22, 2017

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Economic and Investing Cheat Sheet - May 22

Last Week in Review:

There weren’t many economic reports last week, and the data we did get was mixed. In sum the data did nothing to remove the growing feeling that the US economy is losing momentum.

First, the initial look at May data in the form of the Empire State Manufacturing Index badly missed at -1.0 vs. (E) 8.0, but the Philly Fed Business Outlook Survey on Thursday contrarily blew away expectations (38.8 vs. E: 19.6). The net effect is that it put more focus on this week’s flash manufacturing PMI to give us a true look at the pace of manufacturing activity in May.

In the US housing market, the Housing Market Index beat expectations on Monday (70 vs. E: 68), but Housing Starts data on Tuesday whiffed (1.172M vs. E: 1.256M).

The most encouraging report last week was Industrial Production, which beat estimates of 0.4% with a headline print of 1.0%. But, a lot of that “beat” came from auto manufacturing, and activity in that sector has almost certainly peaked (remember Ford is cutting employees amidst more challenging sales environments). Point being, the Industrial Production beat is likely a one off, not the start of a trend.

Rounding things out with the labor market, weekly jobless claims fell 4K to 232K, as the general trend lower remains very well defined. Continuing claims fell to a 29-year low while its four-week moving average fell to a 43-year low. This encouraging report was especially notable because the data was collected from the week corresponding with the survey week for the May jobs report, and the strong print suggests that May could be another very strong month for the labor market. Bottom line, economic data last week did not materially change our outlook for the markets.

This Week’s Preview:

This will actually be a relatively busy week of economic data, as we get the flash manufacturing PMIs, Fed minutes from the May meeting, and other important economic reports.

The most important report this week will be Wednesday’s May flash manufacturing PMI. This will be the first major data point for May and it needs to show stabilization and, better yet, acceleration for stocks to rally.

Second in importance this week will be the FOMC minutes. Markets have priced in a slightly more dovish Fed given the soft inflation data recently, but markets have overestimated the Fed’s dovishness throughout 2017. If the minutes are hawkish, that could push yields and the dollar higher (which would be stock positive).

Meanwhile, there are two reports on housing data, New Home Sales and Existing Home Sales due out on Tuesday and Wednesday, respectively. Investors would welcome a rebound after last week’s soft Housing Starts report.

Finally, both the second look at Q1 GDP and Durable Goods Orders will be released Friday morning. The latter will be closely watched as the gap between soft and hard data remains a concern, and a strong revision to GDP and a good Durable Goods number will help close that gap. Bottom line, economic data remains the key to reigniting the reflation trade (remember, it’s #1 in my list of four events needed to restart the rally). So, the market needs good data and a confident/hawkish Fed for stocks to again test recent highs.

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FOMC Preview and the Next Rate Hike, May 2, 2017

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There is virtually no chance the Fed will hike rates at tomorrow’s meeting, as the chances were slim before the recently disappointing economic data. Now, those chances have declined to near zero. The key question tomorrow is: Just how forcefully will the Fed telegraph the next rate hike?

The answer to that question, taken in the important context of the recent slowing of economic momentum, will decide whether the FOMC decision pushes stocks higher, or whether we see a retracement of the recent gains.

May FOMC Meeting Preview + Next Rate Hikes

Hawkish If: The Fed clearly signals a rate hike is coming in June. Right now, Fed fund futures are pricing in about a 70% chance the Fed does hike rates, but that’s not a consensus expectation, yet. If the Fed specifically points to the “next” meeting in tomorrow’s statement (as it did in the fall of 2015 and 2016) as the likely date of the next rate increase, you will see markets react hawkishly as a June rate hike is not a foregone conclusion. Additionally, if the Fed is still intent on hiking rates in June despite recent economic data disappointments, that might imply a Fed that is more hawkish than previously expected.

Likely Market Reaction: Withheld for subscribers. Unlock with a free two-week trial of The Sevens Report.

Meets Expectations If: The Fed slightly downgrades the assessment of the economy in paragraphs one and two, but also says any slowing of activity is likely only temporary (it’s the temporary part that is the key). Markets expect the Fed to acknowledge the modest loss of economic momentum, but not to make too big a deal out of it.

Likely Market Reaction: Withheld for subscribers. Unlock with a free two-week trial of The Sevens Report.

Dovish If: The Fed materially downgrades economic commentary in paragraph one and downgrades the outlook on inflation, and in doing so materially reduces the chances for a June rate hike. Specifically, to be dovish we would need to see 1) A downgrade of both the growth and inflation language in paragraph one, plus no mention of it being temporary. The net effect would be to remove the expectation for a June rate hike.

Likely Market Reaction: Withheld for subscribers. Unlock with a free two-week trial of The Sevens Report.

Wildcard to Watch

Fed Balance Sheet. As we have covered, the reduction of the Fed’s balance sheet is an important but under reported topic that could result in a more-hawkish-than-anticipated Fed. Specifically, the major questions facing the Fed regarding the balance sheet are:

1) When will the Fed begin to reduce the balance sheet (2017 or 2018)?

2) What securities will the Fed stop buying (just Treasuries or Mortgage Backed Securities, too)?

3) How will the Fed stop reinvesting proceeds (all at once, or gradually)?

How these questions are answered will determine whether the Fed balance sheet is a hawkish influence on markets (yields up, stocks potentially down).

I (and almost everyone else) do not expect the Fed to touch on this in this week’s meeting. However, if the Fed does address this topic, it will come in paragraph five of the statement. Any change there will likely have hawkish implications on markets tomorrow, but again any changes are unlikely.

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Did Trump Just Kill The Reflation Trade? April 13, 2017

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Did Trump Just Kill The Reflation Trade? An excerpt from today’s Sevens Report.

Trump - YellenPresident Trump, in an interview with the WSJ yesterday, appeared to change his policy on the Fed and interest rates. Specifically, Trump said he thought the dollar was getting too strong, that he favored a low interest rate policy, and he was open to keeping Yellen as Fed Chair. It was the second two comments that caught markets attention and caused a “dovish” response in the dollar and bond yields (both of which fell).

The reason these comments were a surprise was because it was generally expected Trump wouldn’t keep Yellen and was in favor of a more hawkish Fed Chair and appointing more hawkish Fed governors (there are currently three vacancies on the Fed President Trump can fill).

So, the market was expecting Trump to be a hawkish influence over the coming years, but yesterday’s comments contradict that expectation.

Going forward, from a currency and bond standpoint (the short term reaction aside) I do not see Trump’s comments as a dovish gamechanger for the dollar or rates. Yes, near term it appears the trend for the dollar is sideways between 99.50ish and 102 while the 10-year yield has broken below support at 2.30%.

But, I don’t see Trump’s comments sending the dollar back into the mid 90’s, nor do I see them sending the 10 year yield below 2%.

I also don’t expect this dovish reaction to be a material boost for stocks, because dovish isn’t positive for stocks any more (in fact the comments are causing the stock sell off this morning—more on that in minute).

Bigger picture, the longer-term path of the dollar and bond yields will be driven by growth, inflation and still ultra-accommodative foreign central banks.

Better economic growth (either by itself or with policy help) is the key to the longer-term direction of the dollar and rates (and we think that longer-term trend remains higher).

However, in the near term, his comments sent the 10 year yield decidedly through support at 2.30%, and that is causing stocks to drop as Treasury yields continue to signal that slower growth and lower inflation are on the horizon. And, since the market has rallied since the election on the hopes of better growth and higher inflation (i.e. the reflation trade) this drop in yields is hitting stocks.

The violation of support in the 10 year yield at 2.30% is important and a potentially near term bearish catalyst for stocks. If the ten year yield doesn’t stabilize and make some effort to rally over the next few days, a test of 2300 or 2275 in the S&P 500 would not shock me.

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Last Week and This Week in Economics, April 3, 2017

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“Last Week and This Week in Economics”—an excerpt from today’s Sevens Report: everything you need to know about the markets in your inbox by 7am, in 7 minutes or less.

Last Week

Sevens Report - April 3, 2017 - This Week and Last WeekEconomic data was sparse again last week, but what data did come beat expectations (although it didn’t do a lot to bridge the gap between survey-based indicators and hard economic data). Still, the numbers did continue to be enough to offset growing Washington noise.

Consumer confidence was the highlight of the week, and it blew away expectations. The number rose to the highest level since summer 2001, coming in at 125.6 vs. (E) 113.8. While a strong number, that is another sentiment survey, and these soaring sentiment surveys need to start reflecting in the hard data starting in Q2 (remember, Q1 GDP is still expected to be around 1%).

The other notable number last week was Pending Home Sales, which also beat estimates, rising 5.5% vs. (E) 2.5%. The biggest takeaway from the March housing data is that it appears higher mortgage rates are not hurting the residential housing market, and that’s an important but underappreciated tailwind on the economy, generally speaking. Going forward, a stable housing market remains critical if there’s any hope to seeing a material economic acceleration.

Bottom line, the last two weeks have been light on economic data, but what numbers we’ve got have generally been good, and as a broad statement the economic data has continued to offset lack of progress in Washington… but that trend will be put to the test this week.

This Week

After two quiet weeks of economic releases, we more than make up for it this week, as the three most-important economic releases of the month all come over the next five days. From a broader context standpoint, with Washington stuck in neutral and hopes of big tax reform fading, economic data needs to stay firm to support stocks. If the data disappoints this week, don’t be surprised if we test last week’s lows.

The most important release this week is Friday’s jobs report. We will do our typical “Jobs Report Preview” later this week, but again it’s important this number is Goldilocks, in that it’s strong enough to support the market, but not so strong that it makes a May rate hike more likely.

The next most-important release this week is the global manufacturing PMIs (out today). The European and Asian numbers have already been released, and focus now turns to the March ISM Manufacturing PMI at 10 a.m. today. This number is taking on a bit more significance due to the disappointment of the flash manufacturing PMI of two weeks ago. It hit a surprise six-month low, so markets will want to see the ISM Manufacturing PMI refute that reading.

The manufacturing PMI is followed by the global manufacturing PMIs out Tuesday night/Wednesday morning. Those reports will again potentially confirm the uptick in global growth, and especially in Europe, where numbers have been strong lately. Domestically, it’s the same story. Economic data needs to support this market in the face of disappointment from Washington. Failure to do that puts this rally at risk.

The only other notable event this week will be the ECB minutes. If the minutes read hawkish, that could put a temporary headwind on HEDJ and long Europe positions. But a dip will likely be a buying opportunity in HEDJ.

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Economics, This Week and Last Week, March 20, 2017

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Every Monday in the Sevens Report, you’ll find a review of last week and a preview of this week. Sign up for your free trial today and start each week “sevens strong.”

Sevens Report - Last Week and This WeekLast week was generally “Goldilocks” from an economic data and Fed standpoint, as economic data continued to be buoyant while the Fed successfully executed a dovish hike (at least in the short term).

Starting with the Fed, the FOMC hiked interest rates 25 bps, as expected, but left the dot projections for 2017 and 2018 unchanged at three hikes each. Given market expectations for an increase in the dots, the reaction was immediately dovish (stocks up, bonds up, gold up, dollar down).

As we said last week, it’s important to see the forest for the trees. Regardless of the Fed’s projections, the first hike of 2017 came three months earlier than expected, and the question going forward isn’t whether the Fed hikes again, but “when” and “how often.”

If inflation data keeps rising and economic activity accelerates (or we actually get corporate tax cuts) the answers to those rate hike questions will be “soon,” and “more than three times.” Point being, don’t confuse the short-term dovish reaction with a reduction in risk from a hawkish Fed throughout 2017. The risk hasn’t changed.

Looking at the economic data last week, it showed an ongoing “reflation trade,” as inflation and growth data beat estimates. Both February PPI and CPI ran a touch “hot,” and showed either bigger-than-expected monthly increases (PPI) or year-over-year price increases that were the biggest in several years (headline CPI rising by 2.7%).

Meanwhile, the first economic data points from March, Empire Manufacturing and Philly Fed, also both beat expectations. Philly was 32.8 vs. (E) 30.0 and New Orders, the leading indicator of the report, rose to 38.6, which is the highest since 1983!

Actual “hard” economic data last week was a touch disappointing on the headline as Retail Sales met expectations and the “Control” group (the best measure of discretionary consumer spending) rose just 0.1% vs. (E) 0.3%. Revisions to the January data were positive and offset the disappointment, though (January control retail sales were revised to 0.8% from 0.4%).

It was a similar result with February Industrial Production being flat vs. (E) 0.2%. However, January data was revised slightly better to -0.1% vs. -0.3%. Meanwhile, the manufacturing sub-index was more positive (up 0.5% vs. (E) 0.4% and January was revised to 0.5% from 0.2%).

Bottom line, the “hard” economic data continues to lag the “soft” sentiment data (i.e. Philly/Empire Surveys) and the running estimate for Q1 GDP (the Atlanta Fed’s GDP Now) is just 0.9%, the lowest in nearly a year.

Again, it’s not an indictment of the rally just yet, but at some point, that GDP number needs to start to rise to meet the surging survey data, otherwise we’ve got a problem.

This Week: Economically speaking this will be a generally quiet week, as the notable data doesn’t come until Friday via the global flash PMIs and February Durable Goods report.

Yet despite the small number of reports, the data is still important, because it has got to continue to help support stocks in the face of ever-dimming policy prospects. So, those numbers (especially durable goods) need to continue to imply economic acceleration.

Other data to watch this week includes housing data (New Homes Sales Wednesday and Existing Home Sales Thursday), but generally housing continues to hold up well in the face of generally higher rates.

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FOMC Takeaways, March 17, 2017

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Linda Yellen

The FOMC raised the fed funds rate 25 basis points, as expected.

The FOMC raised the fed funds rate 25 basis points, as expected.

Below is an excerpt from the full Sevens Report, focusing on the takeaways from the March 15, 2017 Fed meeting. The Sevens Report is everything you need to know about the markets in your inbox by 7am in 7 minutes or less. Sign up for a free 2-week trial today!

Takeaway

The results of this meeting largely met our “What’s Expected,” scenario, as the Fed did hike 25 basis points, but the median “dots” for the number of hikes in 2017 and 2018 were unchanged at three in each year.

So, the Fed generally met well-telegraphed expectations, and the market took it dovishly (as you’d expect). Futures doubled their pre-Fed gains while the dollar dropped sharply and bonds rallied.

Yet, despite the initial moves, I don’t see Thursday’s Fed decision as a bullish game changer, simply because unless we get a surprise downturn in economic data (which won’t be good for stocks), risk still remains for more rate hikes going forward.

So despite the somewhat confusing Fed tactic of rushing to hike in March, only to keep the statement and projections dovish, I’m sticking with my expected market reactions… Stocks rallied, but this isn’t a bullish game-changer; bond yields dropped but it’s likely not a reversal in the uptrend in yields (same for the dollar), and gold rallied and while we may not see a sustained rally just yet, the outlook is becoming more favorable.

Going forward, the market still expects two more hikes in 2017, with June being a close call.

CPI

  • February CPI rose 0.1%, meeting expectations.
  • Core CPI rose 0.2%, also meeting expectations

Takeaway

CPI inflation data largely met expectations on March 15th and the numbers likely didn’t have any effect on the FOMC decision. However, the important point here is that PPI and CPI both confirmed inflation pressures continue to build. Case in point, the year-over-year headline CPI rose to 2.7%, which is a five-year high, while core rose to 2.2%, above the Fed’s stated 2% goal.

From a practical investment management standpoint, this continues to underscore the need for investors to make sure they are positively skewed to inflation for medium- and longer-term accounts (i.e. more equity exposure, reduced long-term bond exposure, TIPS exposure, select hard asset exposure).

Retail Sales

  • February retail sales rose 0.1%, meeting expectations.

Takeaway

There was some noise to cut through in this report, because while the headline met expectations, the more important “control” group (retail sales less autos, gas and building materials) rose just 0.1% vs. (E) 0.3%.

Again, we and others look at the control group because it’s the best measure of discretionary consumer spending. And while that number did miss estimates, the January data saw a big, positive revision, as the control group went from up 0.4% in January to 0.8%. All in all, the numbers were basically in line.

From a market standpoint, this retail sales number still leaves a large and uncomfortable gap between sentiment data (like the Empire Manufacturing Survey and PMIs, which are very strong) and actual, hard data.

Case in point, the Atlanta Fed GDP Now estimate for Q1 GDP fell to 0.9%—hardly robust growth.

Yes, for now the expectation of better growth is off-setting lackluster hard data, but at some point the hard data needs to start to reflect these high sentiment surveys.

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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.

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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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