Return to the Fed

Once the dust settles in the markets after Tuesday's Presidential elections -- and there could be a lot of dust -- attention will likely turn more fully to the possibility of a Fed rate hike at the December 13-14 FOMC Meeting.  It would seem that Fed rhetoric has painted officials into a corner, with failure to tighten then risking to further damage their credibility.   As Atlanta Fed President Lockhardt said last week, the bar to not tighten is high.  And, the market probability of a December Fed rate hike is high.

But, there is still no guarantee that the Fed will hike rates in December.  Vice Chair Stan Fischer's speeches have become slightly less hawkish.   He has recognized that some apparently strong data, such as the 2.9% Q316 Real GDP Growth, was less than meets the eye (about 1% pt of it came from a jump in soybean exports to China.  The September Trade Balance showed that the jump was unwinding).  And, he has pointed out that the Unemployment Rate has not fallen this year despite sold Payroll gains, acknowledging Fed Governor Brainard's point.

Looking ahead, the upshot is that weak US economic data could be more important than strong data with regard to shifting the odds of a December rate hike.  In particular, I would pay attention to the weekly Initial Unemployment Claims and the November Core CPI.  

1.  A move-up in Initial Claims to 270k+ would signal the likelihood of slower growth in economic activity in Q416.  Initial Claims were 265k in the latest week.

                          Initial Claims                                   Real GDP Growth
                          (level, 000s, avg)                             (q/q % change, saar)
October                258
Q316                    259                                                 2.9
Q216                    268                                                 1.4
Q116                    269                                                 0.8
Q415                    270                                                 0.9

2.  A Core CPI print of 0.1% m/m in November, as in October, would underscore that inflation is not a pressing matter for the Fed.

                                            Core CPI
                                            (m/m pct change, sa, avg)
October                                0.1
Q316                                    0.2
Q216                                    0.2
Q116                                    0.2

While a 25 BP hike in December would likely be downplayed by many Street economists as being small, I believe it would be more significant than just itself.  A hike would increase the odds that the Fed will carry through with its forward guidance of 3 more hikes in 2017.  Markets thus could react to a larger degree than might be expected from just a 25 BP hike -- as was the case after the December 2015 Fed hike.  To be sure, other factors could have been at play that hurt economic growth in H116, as well, such as President Obama's executive orders.  How the new Administration's fiscal policy unfolds will be important next year.

       a.  Note that Fed officials have emphasized that forward guidance has been effective in countering the zero-bound restriction on lowering the funds rate.  But, they have been relatively mute regarding the restrictive implications of forward guidance that involves tightening.