Fed “Fed up with foot-dragging”

The second half of the month of February was notable for Fed “consistency” (note: nv=non-voting member)

14-Feb Janet Yellen: “Further adjustment likely needed if economy on track”.

14-Feb J. Lacker (nv): “Next hike should come sooner rather than later”.

15-Feb E. Rosengren (nv): “2017 growth could require faster rate hikes”.

15-Feb N. Kashkari: “Have to wait and see on new fiscal policies”.

22-Feb D. Lockhart (nv): “March is a live meeting”.

24-Feb J. Powell: “March hike is on the table”.

27-Feb R. Kaplan: “Should move sooner rather than later”.

28-Feb P. Harker: “3 hikes are appropriate this year”.

28-Feb J. Williams: “March hike getting serious consideration”.

28-Feb C. Dudley: “Case for tightening has become a lot more compelling”.

What has triggered this stridency?

The economy has been at “full employment” (unemployment at or below 5%) since September 2015, so that´s unlikely to be the reason for all the “rate hike excitement”. Inflation may be a different matter.

The chart indicates that headline PCE is converging on the 2% target. It also indicates that move is closely related to the move in oil prices. Core PCE has remained stable, showing no indication of rising.

Since oil prices fell after mid-2014, the Fed was fond of saying, in its post meeting Statements that:

Inflation is expected to rise to 2 percent over the medium term as the transitory effects of past declines in energy and import prices dissipate and the labor market strengthens further.

I bet that we will never read, in future Statements, that “inflation is expected to remain close to 2% as the transitory effects of past increases in energy prices dissipate”. And they surely will, as oil prices bottomed in February 2016 and for the past several months have remained relatively stable.

The Fed is not likely to miss that “opportunity” to step-up the policy “normalization” process.

So Dudley feels comfortable to say:

It seems to me that most of the data we´ve seen over the last couple of months is very much consistent with the economy continuing to grow at an above-trend pace, job gains remain pretty sturdy, inflation has actually drifted up a little as energy prices have increased.

While John Williams goes further, saying:

So given where we are in terms of unemployment and inflation, we´re very close to achieving our dual mandate goals. Yet monetary policy essentially still has the pedal to the metal, with interest rates that remain near historical lows. We need to gradually ease our foot off the gas in order to avoid a “too hot” economy that in the end isn´t sustainable.

Inadvertently, Trump is helping the Fed break out of the “rate lethargy” with all the spending and deregulation promises, although he still has given no specifics. People also tend to forget the darker side of Trump´s promises, things like immigration clampdown and trade wars.

As is well known, going by the name of “reflation trade”, Trumps election “lifted” the markets.

Inflation Expectations (10-yr), which had slowly begun to rise during the summer, jumped on the election, quickly converging to the 2% “magic #”. Since the inauguration, they have maintained that level.

The dollar also jumped following the election, but had begun to retrench even before the inauguration. Recent Fed “messages” has allowed a dollar revival

Bond Spreads show an interesting pattern. The “Trump boost” quickly increased the 10yr-2yr yield spread, consistent with the view of higher growth and inflation that would result from Trump policies. Note, however, that longer term spreads fell. This would imply that the “boost” would be rather short-term.

By the time of inauguration, shorter-term spreads had begun to retrench. Longer-term spreads, meanwhile, have remained at the new low level.

Joining the dots: Markets do not believe the Fed will let inflation go above 2% for any significant length of time; the dollar has “mixed feelings” about the “reflation”, while the bond market is showing less excitement even about a relatively short boost to growth and inflation.

Another story altogether comes from the stock market. The election boost was “renewed” following the inauguration, with the S&P 500 up almost 15% in the past four months.

Not surprising that a lot of talk of stocks “overvaluation” comes up. For one, stock investors are less risk averse than bond investors. In addition, the market rise has been significantly driven by financials, reflecting heightened expectations of earlier and more rapid interest rate increases by the Fed.

It will be interesting to follow the interplay between Trump and the Fed. The Trump “confidence booster” has turned the Fed more hawkish. It is one of our Tenets that “confidence doesn´t matter”. In the present case, the Trump “boosting promises” may turn out to be largely a mirage. On the other hand, Fed “hawkishness” is for real, and may have a strong negative impact even if it remains contained only in words!


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