Market participants are debating whether Treasury yields will fall or rise in the next few months and whether the stock market will break above their range. The FOMC Statement on Wednesday may determine which side of the debate is right. Here's why I think the Statement risks keeping Treasury yields in the recently high range and stocks range bound.
Consensus and I expect the Fed to refrain from hiking rates at this week's FOMC Meeting. But, the Statement is the key to how the markets will trade afterwards, and it risks being hawkish -- saying, in line with Yellen's Jackson Hole Speech, that the labor market is approaching full employment and inflation is approaching the Fed's target. The combination of no hike and a hawkish Statement could be a compromise between the hawks and doves on the FOMC.
A hawkish Statement would likely result in knee-jerk selling of Treasuries and stocks, as it would make the markets think a December rate hike is in play. Such sell-offs tend to be overdone, however, and this case should not be an exception -- the December FOMC Meeting is far off and nothing is guaranteed. Indeed, early considerations suggest most key US economic data in the next month or so will be strong
enough to keep the risk of a December hike alive in the markets, but not strong enough to eliminate all doubt. So, after the initial reaction and volatility, Treasury yields would likely
stay in their recently higher range and stocks remain in their range.
1. Generally, the risk is that US economic data pertaining to September and October will strengthen as the weather returns to normal after a very hot August.
a. In particular, Ex Auto Retail Sales should post gains, after having fallen in July and August.
2. September Nonfarm Payrolls should remain moderate, around 150k, as the Claims data show little change since the August Survey Week. (Such a moderation in Payrolls happened in August-September last year, as well). Fed hawks, such as Williams, view this pace of net job creation as strong enough to warrant higher rates. But Fed doves, like Brainard, are not convinced.
3. Similarly, the September Unemployment Rate should be little changed from August's 4.9%.
a. But, an uptick in the Unemployment Rate to 5.0% cannot be ruled out. The Rate was 4.922% in August (up from 4.88% in July), so a small uptick could round to 5.0% -- which would have a positive headline effect on Treasuries and stocks.
4. In a broad sense, Q416 Real GDP Growth could slow to under 2.0% -- in
line with the early forecast of the NY Fed's nowcast model and
consistent with the tightening of bank lending standards in mid year -- but
the q/q slowdown could mask a modest speedup in economic activity during the quarter.
a. A speedup during the quarter could lead to a pickup in Q117 Real GDP Growth. The renewed move up in the ECRI Leading Index in the past couple of weeks supports this possibility. But, winter weather plays the most important role in determining the strength of GDP growth in the Q1 of a year.
b. Note that the Atlanta Fed's nowcast model's forecast of Q316 GDP
fell to 3.0% from 3.3% after last week's data releases. The NY Fed's
model had been projecting 2.8% for Q316 but will not be updated until
next Friday (as it refrained from doing so ahead of the FOMC Meeting).
Upcoming inflation-related data could feed into the hawks' camp.
1. Average Hourly Earnings risk printing an above-trend 0.3% m/m for both September and October, based on calendar considerations. The y/y would return to its recent high of 2.6% in the October Employment Report. But, AHE should slow to 0.1% m/m and 2.4% y/y in the November Report (due in early December), based on calendar consideration.
2. Whether the Core CPI prints 0.3% m/m in September, as in August, is a tough call. A number of the components that rose notably in August could be one-off -- just snapbacks from declines in June and July -- so could soften in September. But, the bi-monthly sampling for the CPI means that some of the increases -- such as for the EpiPen -- could be captured in the September CPI survey as well as in the August survey.
3. But, the August Core PCE Deflator is likely to weaker than the 0.3% m/m Core CPI as a result of differences in composition and definition.
Aside from the US economic data, the outlook for fiscal policy may be clearer at the December FOMC Meeting. Expectations of large fiscal stimulus -- if Trump wins -- or even moderate fiscal stimulus -- if Clinton wins -- could encourage the Fed to hike.
a. Note that the sell-off in German Bunds has been attributed to the ECB failing to extend its bond buying program. But, it also could be attributed to the ECB pushing the European countries to boost fiscal stimulus.
b. I continue to think that aggressive fiscal stimulus is the major downside risk for Treasury prices.
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