Stock Rally Likely To Continue Past Next Week's FOMC Meeting

There are several reasons why the stock market rally will likely continue after the widely expected 25 BP Fed rate hike next Wednesday (December 14).  In broad terms, they are /1/ a strong economy, /2/ a Fed emphasis of a gradual further tightening in 2017, and /3/ expectations of Trump's fiscal and economic policies.  These reasons should propel the rally at least into January.   They also should keep upward pressure on Treasury yields and the dollar, but -- thanks to low inflation -- the upward pressure may be modest.

1.   Strong Economy:  
           a.  Both the NY Fed and Atlanta Fed's models are now projecting about 2.5% (q/q, saar) for Q416.   While moderate from an historical perspective, this pace is above trend.  It is also stronger than the 0.9% Real GDP Growth Rate in Q415 when the Fed last tightened by 25 BPs.

           b.   Initial Claims have averaged 255k so far in Q416, slightly lower (and thus stronger) than the 259k Q316 average.  Continuing Claims have been on a downtrend since September, after stalling from April through August.

           c.  The ECRI Leading Index has risen sharply in the past few weeks, suggesting a further pickup in GDP Growth into Q117.

  ECRI Leading Index (level, July Through November)


2.  Gradual Fed Tightening in 2017:
          a.  NY Fed President Dudley said this week that he favored a gradual approach to tightening.

           b.  Uncertainty about the scope of fiscal policy changes should keep the Fed cautious until there is more certitude.  This will likely happen by next Spring or Summer.  So, the Fed should fade from the markets' forefront in early 2017.

           c.  The Fed is likely to emphasize a gradual approach in the Statement and in Yellen's post-meeting press conference, the same as it has done in the recent past.

            d.  But, there could be some narrowing in the 2017 range of "dots" from September's 1.1-1.8% range.  An upward adjustment in the lower bound of this range is the most likely change, but the consensus expectation of 2-3 more hikes in 2017 should remain intact.

3.  Trump's Policies:
           a.  There are 3 main issues:  /1/ the magnitude of the tax cut, /2/ the extent and speed of deregulation, and /3/ the approach taken on foreign trade.

            b.  The Republican dislike of large Federal Budget Deficits could limit the size of the tax cut.  In Congressional testimony earlier this month, Yellen cautioned about overdoing fiscal stimulus now that the economy is close to full employment.   But, she did not mention that it would fit with her idea of running a hot economy to stimulate stronger productivity gains.

            c.  The Trump Administration's presumably pro-business/less regulatory approach should be a factor preventing the sharp slowdown in GDP Growth seen after the December 2015 Fed rate hike.   Obama's renewed shift to executive orders in Q415 likely was partly responsible for the slowdown.

             c.  A move toward bi-lateral trade agreements in order to push other countries to eliminate tariffs would be a positive for the US economy and the dollar.  A trade war, however, would be bad.  I wonder whether Trump's telephone call to the Taiwanese president was part of a strategy to "soften up" the Chinese government ahead of such trade negotiations.