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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.

This FOMC review is part of the full Sevens Report. For a monthly cost of less than one client lunch, we firmly believe we offer the best value in the independent research space—and you can get two weeks free by signing up for our trial version. Try it today and see what a difference the Sevens Report can make for you every morning.

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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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.

Cut through the noise and understand what’s truly driving markets, as this new political and economic reality evolves. Get your free two-week trial of the Sevens Report today.