While the FOMC Minutes suggested the odds are high that the Fed will either hike or signal an upcoming hike at the March 14-15 FOMC meeting, it is not a slam dunk that it will. Some of the key US economic data scheduled over the next couple of weeks risk softening a bit, although likely remaining strong enough to support a tightening. Conversely, some of the high inflation prints should be discounted as temporary. But, uncertainty surrounding international developments, particularly the triggering of Article 50 to formally begin the process of Brexit and the French Presidential elections, could put the Fed on pause as risk management considerations behoove it to wait to see the market impacts.
The market impacts of these international developments may not be fully known until after the May 2-3 FOMC meeting. UK Prime Minister May said Article 50 would be triggered by the end of March. The first round of the French elections is on April 23 and the second round on May 7. The fear is that the election outcome could move the EU a step further to a breakup. As a result, the Fed might wait until the June FOMC meeting to decide whether to tighten.
Market behavior could determine the amount of significance the Fed places on a risk management approach to monetary policy. A sharp drop in the euro and/or pound, along with a flight-to-safety rally in Treasuries, could be the needed signal that the probability of a EU breakup has risen to a level that should make Fed officials think twice about the desirability of hiking rates. But, such market moves are not likely until the feared French election outcome looks to be a strong possibility -- the window being between the first and second rounds of the election. So, this market signal will not likely be seen at the March FOMC Meeting but could be relevant at the May meeting. And, Fed officials may have to weigh risk management considerations without clear market signals at the March FOMC meeting.
US economic data to be released over the next two weeks will be weighed at the March meeting. The February Mfg ISM, due March 1, is one important statistic. Consensus is for an uptick to 56.3 from the already high 56.0 January level. But, the most reliable evidence, the Markit Mfg PMI (correctly predicting direction in each of the past 6 months) points to a decline. Another piece of negative evidence is that this year's seasonal factors subtract 0.2 pt more from the January-February m/m change in the Mfg ISM than last year's seasonals. Note that today's release of January Durable Goods Orders showed soft
internals, as Orders Excluding Transportation and Capital Goods Orders
Excluding Civilian Aircraft both slipped. To be sure, the Mfg ISM would have to fall below 53.0 -- the high end of the range seen before last December, however, to raise any serious concern about economic growth.
The January Core PCE Deflator is another important statistic due next week. Consensus is for a slight speedup to +0.2% m/m from +0.1% in December. But, like the CPI, which much of the PCE Deflator is derived from, temporary factors are behind the speedup. These factors include a bounce-back from heavy discounting of apparel in the holiday season, start-of-year price hikes, and a pass-through of higher oil prices to items such as airfares. So, a high print should be discounted.
Monday, February 27, 2017
Wednesday, February 22, 2017
Latest FOMC Minutes More Hawkish Than December's, But...
The minutes of the January 31/February 1 FOMC Meeting are more hawkish than the minutes of the December meeting. There is much more discussion of when to tighten and the majority appears to be comfortable hiking rates soon. But, the consensus (or leadership) still favor a gradual approach, which may be why this more hawkish sentiment was not captured in the FOMC Statement following the meeting. While a rate hike in March is not a slam dunk, the odds of one -- or in May -- would appear to be high.
Here are relevant extracts. All but one are from the section of the Committee's views. The most dovish extract is from the section on the Committee's Policy Action and thus is presumably more important than the others.
January 31/February Meeting
Hawkish: note the word "many," meaning this is consensus. Also, the data just have to be in line with expectations -- likely easily done given the boost to the economy from the warm winter. A caveat is the word "might" -- so still not a slam dunk for March.
In discussing the outlook for monetary policy over the period ahead, many participants expressed the view that it might be appropriate to raise the federal funds rate again fairly soon if incoming information on the labor market and inflation was in line with or stronger than their current expectations or if the risks of overshooting the Committee’s maximum-employment and inflation objectives increased.
Moderately Hawkish -- particularly saying "at an upcoming meeting."
A few participants noted that continuing to remove policy accommodation in a timely manner, potentially at an upcoming meeting, would allow the Committee greater flexibility in responding to subsequent changes in economic conditions.
Mildly Hawkish -- Hypothetical. In December "many" participants thought the risk of undershooting the normal rate of unemployment "had increased somewhat."
Several judged that the risk of a sizable undershooting of the longer -run normal unemployment rate was high, particularly if economic growth was faster than currently expected. If that situation developed, the Committee might need to raise the federal funds rate more quickly than most participants currently anticipated to limit the buildup of inflationary pressures.
Dovish -- Found in the discussion of the Committee's Policy Action, so more important than the comments in the Committee's views.
Many members continued to see only a modest risk of a scenario in which the unemployment rate would substantially undershoot its longer -run normal level and inflation pressures would increase significantly.
Dovish -- But only a "few others."
However, with inflation still short of the Committee’s objective and inflation expectations remaining low, a few others continued to see downside risks to inflation or anticipated only a gradual return of inflation to the 2 percent objective as the labor market strengthened further.
A Hawkish Step That Could Hurt Long-End of Treasury Curve. In December, several participants said "circumstances that might warrant changes to the path for the federal funds rate could also have implications for the reinvestment of proceeds from maturing Treasury securities and principal payments from agency debt and mortgage-backed securities." In the latest meeting, there was general agreement that discussion of these possible conditions should begin.
Participants also generally agreed that the Committee should begin discussions at upcoming meetings about the economic conditions that could warrant changes in the existing policy of reinvesting proceeds from maturing Treasury securities and principal payments from agency debt and mortgage-backed securities, as well as how those changes would be implemented and communicated.
These extracts are more hawkish than the tentative sentence in the December minutes:
December Meeting
Several members noted that if the labor market appeared to be tightening significantly more than expected, it might become necessary to adjust the Committee’s communications about the expected path of the federal funds rate, consistent with the possibility that a less gradual pace of increases could become appropriate.
Sunday, February 19, 2017
Upcoming Clues Regarding a Fed Rate Hike
Did Yellen point to a March rate hike in her Semi-Annual Monetary Policy testimony, by saying it may be better to tighten sooner rather than later? Or, was it just a throw-away comment, representative of the standard Fed line that all meetings are "live"? These questions will probably be a focus of market commentary in the next few weeks. The markets will likely examine the January 31/February 1 FOMC Minutes and upcoming US economic data for clues. My guess is these clues will not significantly change market expectations for the March FOMC Meeting -- allowing the stock market to rally further and Treasury market to stay in a trading range over the next few weeks. But, it is conceivable the Fed might decide at the March 14-15 meeting that non-economic reasons on top of the broadly strong macroeconomic background justify a hike -- either at that meeting or signaled then for the May meeting -- regardless of what printed in the prior few weeks.
Even if the Fed hikes in March or signals one for May, the stock market reaction should be muted -- and any pullback temporary -- for a couple of reasons. A hike would fit with the Fed's forward guidance, so is at least partly built in -- assuming the Fed does not change the forward guidance in its "dots" chart. Also, the strong Q117 economic background and the expectation of future fiscal stimulus remain an offset to the tightening.
Evidence in the January 31/February 1 FOMC Minutes
This week, the markets will likely focus on the Minutes of the January 31/February 1 FOMC Meeting (due February 22) for a clue as to the significance of Yellen's comment. The Minutes may suggest it was a throw-away comment. Inasmuch as the notion of "sooner rather than later" was not included in the FOMC Statement, the idea presumably was not generally agreed to be of imminent importance at the meeting. And, Yellen's testimony might have been prompted by the strong January Payroll gain, which had not been released at the time of the FOMC Meeting.
But, some subtle changes to a key sentence in the Minutes would be a hawkish clue. The key sentence can be found in the Minutes of the December 2016 FOMC Meeting. It shows that tightening at a faster-than-gradual pace was viewed by participants as more of a possibility than a likelihood: "Several members noted that if the labor market appeared to be tightening significantly more than expected, it might become necessary to adjust the Committee’s communications about the expected path of the federal funds rate, consistent with the possibility that a less gradual pace of increases could become appropriate."
A repetition of this sentence in the January-February Meeting Minutes would suggest that Yellen's comment was a throw-away, although the fact that she said it suggests that she was one of the "several" members expressing this view at the meeting. Her testimony would take on more significance if this sentence were strengthened. For example, "many" could replace "several," "may" or "would" could replace "might," "likelihood" could replace "possibility," or "would" could replace "could." Yellen used the word "would" in her testimony: "As I noted on previous occasions, waiting too long to remove accommodation would be unwise, potentially requiring the FOMC to eventually raise rates rapidly...." But, it is not clear whether this means the sentence in the Minutes was changed.
Evidence in Upcoming US Economic Data
The markets also will likely weigh the economic data released over the next few weeks for clues regarding a March rate hike. While most of the upcoming data should be strong enough to justify a tightening, some important ones -- February Unemployment Rate and Average Hourly Earnings -- may not.
The February Employment Report (due March 10) will likely show a good-sized gain in Payrolls, helped by the warm winter. But, Average Hourly Earnings and the Unemployment Rate may be more benign, as was the case in January -- and these parts of the report could be key to whether the Fed hikes in March.
a. Calendar considerations suggest a modest 0.1-0.2% m/m for February Average Hourly Earnings -- which would raise the y/y only slightly to a still-low 2.6% from 2.5% in January (both below the 2.8% 2016 pace).
b. A steady or higher Unemployment Rate would suggest that the "supply-side" of the economy is expanding to accommodate strong growth -- and that restraint on demand from a Fed rate hike is not needed. But, there is no reliable evidence regarding the m/m direction of the Unemployment Rate. So, market uncertainty regarding a Fed rate hike may persist at least into March 10.
The February Markit Mfg PMI (due February 21) will be noteworthy since it has correctly predicted the direction of the important Mfg ISM in each of the past 6 months. Consensus looks for an uptick. But, even a dip in either Index would keep it at a high level, keeping alive the possibility of a rate hike.
Non-Economic Reasons for A Hike
The Fed still may decide to hike in March despite the macroeconomic evidence not being entirely persuasive, as the decision may boil down to non-economic reasons. The Fed might find tightening in March politically desirable before it can be interpreted as in opposition to the proposed fiscal stimulus. Or, Yellen may be willing to take the heat in her last year as Chair.
In any of these cases, the background of a strong economy in Q117 could serve as an excuse to tighten, even though some of the strength may be weather-related and thus temporary, the Unemployment Rate may have stopped falling, and inflation is under control. Both the Atlanta and NY Fed's models project above-trend GDP growth in Q117 (Atlanta 2.4%, NY Fed 3.1%, trend 1.5-1.7%). The Fed could say that economic growth is in line with its expectations, so that a hike is consistent with its gradual approach to tightening.
Even if the Fed hikes in March or signals one for May, the stock market reaction should be muted -- and any pullback temporary -- for a couple of reasons. A hike would fit with the Fed's forward guidance, so is at least partly built in -- assuming the Fed does not change the forward guidance in its "dots" chart. Also, the strong Q117 economic background and the expectation of future fiscal stimulus remain an offset to the tightening.
Evidence in the January 31/February 1 FOMC Minutes
This week, the markets will likely focus on the Minutes of the January 31/February 1 FOMC Meeting (due February 22) for a clue as to the significance of Yellen's comment. The Minutes may suggest it was a throw-away comment. Inasmuch as the notion of "sooner rather than later" was not included in the FOMC Statement, the idea presumably was not generally agreed to be of imminent importance at the meeting. And, Yellen's testimony might have been prompted by the strong January Payroll gain, which had not been released at the time of the FOMC Meeting.
But, some subtle changes to a key sentence in the Minutes would be a hawkish clue. The key sentence can be found in the Minutes of the December 2016 FOMC Meeting. It shows that tightening at a faster-than-gradual pace was viewed by participants as more of a possibility than a likelihood: "Several members noted that if the labor market appeared to be tightening significantly more than expected, it might become necessary to adjust the Committee’s communications about the expected path of the federal funds rate, consistent with the possibility that a less gradual pace of increases could become appropriate."
A repetition of this sentence in the January-February Meeting Minutes would suggest that Yellen's comment was a throw-away, although the fact that she said it suggests that she was one of the "several" members expressing this view at the meeting. Her testimony would take on more significance if this sentence were strengthened. For example, "many" could replace "several," "may" or "would" could replace "might," "likelihood" could replace "possibility," or "would" could replace "could." Yellen used the word "would" in her testimony: "As I noted on previous occasions, waiting too long to remove accommodation would be unwise, potentially requiring the FOMC to eventually raise rates rapidly...." But, it is not clear whether this means the sentence in the Minutes was changed.
Evidence in Upcoming US Economic Data
The markets also will likely weigh the economic data released over the next few weeks for clues regarding a March rate hike. While most of the upcoming data should be strong enough to justify a tightening, some important ones -- February Unemployment Rate and Average Hourly Earnings -- may not.
The February Employment Report (due March 10) will likely show a good-sized gain in Payrolls, helped by the warm winter. But, Average Hourly Earnings and the Unemployment Rate may be more benign, as was the case in January -- and these parts of the report could be key to whether the Fed hikes in March.
a. Calendar considerations suggest a modest 0.1-0.2% m/m for February Average Hourly Earnings -- which would raise the y/y only slightly to a still-low 2.6% from 2.5% in January (both below the 2.8% 2016 pace).
b. A steady or higher Unemployment Rate would suggest that the "supply-side" of the economy is expanding to accommodate strong growth -- and that restraint on demand from a Fed rate hike is not needed. But, there is no reliable evidence regarding the m/m direction of the Unemployment Rate. So, market uncertainty regarding a Fed rate hike may persist at least into March 10.
The February Markit Mfg PMI (due February 21) will be noteworthy since it has correctly predicted the direction of the important Mfg ISM in each of the past 6 months. Consensus looks for an uptick. But, even a dip in either Index would keep it at a high level, keeping alive the possibility of a rate hike.
Non-Economic Reasons for A Hike
The Fed still may decide to hike in March despite the macroeconomic evidence not being entirely persuasive, as the decision may boil down to non-economic reasons. The Fed might find tightening in March politically desirable before it can be interpreted as in opposition to the proposed fiscal stimulus. Or, Yellen may be willing to take the heat in her last year as Chair.
In any of these cases, the background of a strong economy in Q117 could serve as an excuse to tighten, even though some of the strength may be weather-related and thus temporary, the Unemployment Rate may have stopped falling, and inflation is under control. Both the Atlanta and NY Fed's models project above-trend GDP growth in Q117 (Atlanta 2.4%, NY Fed 3.1%, trend 1.5-1.7%). The Fed could say that economic growth is in line with its expectations, so that a hike is consistent with its gradual approach to tightening.
Tuesday, February 14, 2017
Yellen's Testimony and the January PPI -- Implications for March Rate HIke?
Yellen, in her Semi-Annual Monetary Policy Testimony, appeared to raise the risk of a Fed rate hike at the March 14-15 FOMC Meeting, as her emphasis on the inflationary consequence of waiting too long to tighten was not in the last FOMC Statement. To be sure, this emphasis could have been just a throw-away comment, as it is the standard Fed line. It may have been made more to justify the Fed's expectations to hike rates this year than to point specifically to a March hike.
The minutes of the January 31-February 1 FOMC Meeting could shed light on the significance of her comment. The fact that the risk of waiting too long to hike did not appear in the Statement suggests the minutes will indicate that any such thought was just the standard background view of monetary policy. Nevertheless, a strong February Employment Report, due March 10, could be used as an excuse to tighten -- if the Fed wants to hike.
Today's high print of the January PPI (+0.6% m/m Total, +0.4% Core) does not suggest that a pickup in inflation will trigger a March rate hike. The high print resulted from a jump in a component -- trade services prices -- that is volatile and somewhat suspect in its relevance regarding inflation. Excluding Trade Services, the Core PPI rose only 0.2% m/m, in line with the 0.1-0.2% range seen in 8 of 12 months of 2016.
The minutes of the January 31-February 1 FOMC Meeting could shed light on the significance of her comment. The fact that the risk of waiting too long to hike did not appear in the Statement suggests the minutes will indicate that any such thought was just the standard background view of monetary policy. Nevertheless, a strong February Employment Report, due March 10, could be used as an excuse to tighten -- if the Fed wants to hike.
Today's high print of the January PPI (+0.6% m/m Total, +0.4% Core) does not suggest that a pickup in inflation will trigger a March rate hike. The high print resulted from a jump in a component -- trade services prices -- that is volatile and somewhat suspect in its relevance regarding inflation. Excluding Trade Services, the Core PPI rose only 0.2% m/m, in line with the 0.1-0.2% range seen in 8 of 12 months of 2016.
Sunday, February 12, 2017
Stock Market Rally Should Survive Yellen and CPI Next Week; Comment on Tax Reform and Immigration Order
The stock market is likely to continue to rally as it absorbs some important information in the next few weeks. At the same time, the Treasury market is likely to remain range-bound. Of particular interest will be Yellen's Semi-Annual Monetary Policy Testimony (February 14-15), a possibly high January CPI (February 15), and a promised tax reform proposal from the Administration.
Yellen's testimony will reflect the consensus view of the FOMC at its last meeting (January 31-February 1), as summarized in the Statement coming out of that meeting. So, the testimony should not contain any new insights into Fed policy and have little, if any, lasting effect on the stock market. Yellen will cite expectations of moderate economic growth, acknowledge that growth picked up in H216, that the stronger pace looks to have continued in Q117, and that the labor market has strengthened. She will say that inflation remains below the Fed's 2% target, but is expected to reach the desired pace ahead. She also will reaffirm a gradual approach to policy tightening. But, she may not be firm about the 3 rate hikes this year suggested by the Fed's "dots" chart. Some of the hawkish rate hike expectations in the "dots" chart may have assumed large fiscal stimulus coming from the Trump Administration. Since the size and composition of the fiscal stimulus proposal are still unknown, Yellen could be cautious in putting a figure on the number of hikes this year.
Evidence of a pickup in core inflation could be a factor that influences the number of Fed rate hikes in 2017. But, a high January Core CPI won't do the trick, as it could be a result of one-off factors. Start-of-year price hikes could dominate seasonal factors. And, heavy holiday-related discounting of apparel goods in November-December could have unwound in January. To be sure, the consensus estimate of +0.4% m/m still seems to be too aggressive. Some of the discounting may have resulted from more permanent factors, such as the stronger dollar and subdued wage inflation. These latter factors could have persisted in January. Also, the January Core CPI has been no more than 0.1% pt above the prior 12-month m/m average in the past few years (see table below). A high print should be dismissed as one-off by the markets, either quickly after the print or soon thereafter.
Core CPI (m/m percent change)
January Prior 12-Month Average
2017 na 0.2
2016 0.3 0.2
2015 0.2 0.1
2014 0.1 0.1
2013 0.1 0.2
The Administration's tax reform proposal is expected to be revealed over the next 2-3 weeks. Whatever the details of the corporate tax proposal, the impact will vary across industries and companies. As a result, there should be differing responses by sector/company stock, but on balance the market should be helped by it.
Disagreement among businesses regarding the specifics of a corporate tax cut would be in contrast to their near-unanimous condemnation of Trump's executive order to curb immigration from 7 Muslim countries. Tech companies, in particular, argued that the order would prevent their hiring the best workers from around the world. Ironically, by wanting to restrict immigration for security reasons, Trump is making the same mistake made by Obama -- using executive orders to achieve goals, which, regardless of their merits, has the unintended consequence of hurting US economic growth. The courts may have saved Trump from committing this mistake -- and he should be grateful for their doing so.
Yellen's testimony will reflect the consensus view of the FOMC at its last meeting (January 31-February 1), as summarized in the Statement coming out of that meeting. So, the testimony should not contain any new insights into Fed policy and have little, if any, lasting effect on the stock market. Yellen will cite expectations of moderate economic growth, acknowledge that growth picked up in H216, that the stronger pace looks to have continued in Q117, and that the labor market has strengthened. She will say that inflation remains below the Fed's 2% target, but is expected to reach the desired pace ahead. She also will reaffirm a gradual approach to policy tightening. But, she may not be firm about the 3 rate hikes this year suggested by the Fed's "dots" chart. Some of the hawkish rate hike expectations in the "dots" chart may have assumed large fiscal stimulus coming from the Trump Administration. Since the size and composition of the fiscal stimulus proposal are still unknown, Yellen could be cautious in putting a figure on the number of hikes this year.
Evidence of a pickup in core inflation could be a factor that influences the number of Fed rate hikes in 2017. But, a high January Core CPI won't do the trick, as it could be a result of one-off factors. Start-of-year price hikes could dominate seasonal factors. And, heavy holiday-related discounting of apparel goods in November-December could have unwound in January. To be sure, the consensus estimate of +0.4% m/m still seems to be too aggressive. Some of the discounting may have resulted from more permanent factors, such as the stronger dollar and subdued wage inflation. These latter factors could have persisted in January. Also, the January Core CPI has been no more than 0.1% pt above the prior 12-month m/m average in the past few years (see table below). A high print should be dismissed as one-off by the markets, either quickly after the print or soon thereafter.
Core CPI (m/m percent change)
January Prior 12-Month Average
2017 na 0.2
2016 0.3 0.2
2015 0.2 0.1
2014 0.1 0.1
2013 0.1 0.2
The Administration's tax reform proposal is expected to be revealed over the next 2-3 weeks. Whatever the details of the corporate tax proposal, the impact will vary across industries and companies. As a result, there should be differing responses by sector/company stock, but on balance the market should be helped by it.
Disagreement among businesses regarding the specifics of a corporate tax cut would be in contrast to their near-unanimous condemnation of Trump's executive order to curb immigration from 7 Muslim countries. Tech companies, in particular, argued that the order would prevent their hiring the best workers from around the world. Ironically, by wanting to restrict immigration for security reasons, Trump is making the same mistake made by Obama -- using executive orders to achieve goals, which, regardless of their merits, has the unintended consequence of hurting US economic growth. The courts may have saved Trump from committing this mistake -- and he should be grateful for their doing so.
Sunday, February 5, 2017
Stock Market Rally to Continue -- Some Macro Considerations
The stock market rally is likely to continue into the Spring, helped by a strong economy and the possibilities of less-than-feared policies coming from Trump and a Fed on hold longer than is now expected.
Early evidence points to a Real GDP speedup in Q117, with the Atlanta Fed's model projecting 3.4% (q/q, saar) and the NY Fed's model 2.9%, after the +1.9% Real GDP growth in Q416. Some of the speedup likely results from temporary factors, such as the unseasonably warm winter, and should unwind in the Spring. At this point, the risk is for somewhat slower GDP growth in Q217 than in Q117.
By then, however, tax reform and infrastructure plans will likely be more in focus and help to lift expectations of stronger growth ahead -- which could keep stocks climbing as the economy slows. Since these programs have to be passed by Congress, there could be many alterations made to Trump's proposals and the final products may be far less extreme than Trump's election promises. This week's shift in some Republicans' approach to ObamaCare -- from repeal to reform -- is a hopeful sign that rationality will prevail in all the fiscal policy proposals.
With Real GDP growth likely to be stronger in Q117 than in Q217, the macroeconomic evidence should favor a Fed rate hike in March more than in June. A March hike, however, is highly unlikely, given the absence of a hint in this week's FOMC Statement -- the last before the March FOMC Meeting. The Fed likes to signal an upcoming hike in the prior meeting's Statement in order to prepare the markets. Although Yellen will present the Semi-Annual Monetary Policy Report to Congress on February 14-15, she should not signal a March rate hike then. This testimony typically is tied to the prior FOMC Statement, as both the testimony and the Statement reflect the latest consensus view of the FOMC.
To be sure, the Fed could use the March meeting to signal a hike at the May FOMC meeting. A hike in May would be unusual, however, since a news conference is not normally scheduled after that month's meeting. A March signal also could spark market concerns that the Fed is abandoning its gradual approach to tightening. A May hike, absent a hint, would presumably require very strong real-side and high inflation data to be seen ahead of the meeting. This requirement will probably not be met, as the economic data going into the May FOMC meeting, e.g., March-April Initial Claims and Payrolls, should begin to show post-winter paybacks.
A June rate hike is not a slam-dunk either. Besides the possibility of slower economic growth extending into Q317, political considerations could give the Fed pause. A hike in June could be problematic politically if it is seen to have been done in anticipation of fiscal stimulus. Trump and a number of Republican Congressmen already are dubious about the need for Fed independence, and they could view a June hike as politically motivated to thwart Trump's policies. As a result, Fed officials may require solid support from the data and markets if they are to hike. Based on this thought process, it is conceivable that the next Fed hike will be in December.
Yellen will probably be asked questions about fiscal policy at her monetary policy testimony. She will likely say that the economic boost from any fiscal stimulus will depend on the composition of the policy, similar to the ideas expressed in a recent speech by Fed Governor Brainard. She also may repeat that the desired amount of the fiscal stimulus, with its attendant expansion of the Federal deficit, should be evaluated in light of the fact that the economy is now operating close to full employment. This word of caution would argue for a smaller fiscal package than Trump has proposed. It could weigh on the stock market somewhat, but not by enough to derail the rally.
Early evidence points to a Real GDP speedup in Q117, with the Atlanta Fed's model projecting 3.4% (q/q, saar) and the NY Fed's model 2.9%, after the +1.9% Real GDP growth in Q416. Some of the speedup likely results from temporary factors, such as the unseasonably warm winter, and should unwind in the Spring. At this point, the risk is for somewhat slower GDP growth in Q217 than in Q117.
By then, however, tax reform and infrastructure plans will likely be more in focus and help to lift expectations of stronger growth ahead -- which could keep stocks climbing as the economy slows. Since these programs have to be passed by Congress, there could be many alterations made to Trump's proposals and the final products may be far less extreme than Trump's election promises. This week's shift in some Republicans' approach to ObamaCare -- from repeal to reform -- is a hopeful sign that rationality will prevail in all the fiscal policy proposals.
With Real GDP growth likely to be stronger in Q117 than in Q217, the macroeconomic evidence should favor a Fed rate hike in March more than in June. A March hike, however, is highly unlikely, given the absence of a hint in this week's FOMC Statement -- the last before the March FOMC Meeting. The Fed likes to signal an upcoming hike in the prior meeting's Statement in order to prepare the markets. Although Yellen will present the Semi-Annual Monetary Policy Report to Congress on February 14-15, she should not signal a March rate hike then. This testimony typically is tied to the prior FOMC Statement, as both the testimony and the Statement reflect the latest consensus view of the FOMC.
To be sure, the Fed could use the March meeting to signal a hike at the May FOMC meeting. A hike in May would be unusual, however, since a news conference is not normally scheduled after that month's meeting. A March signal also could spark market concerns that the Fed is abandoning its gradual approach to tightening. A May hike, absent a hint, would presumably require very strong real-side and high inflation data to be seen ahead of the meeting. This requirement will probably not be met, as the economic data going into the May FOMC meeting, e.g., March-April Initial Claims and Payrolls, should begin to show post-winter paybacks.
A June rate hike is not a slam-dunk either. Besides the possibility of slower economic growth extending into Q317, political considerations could give the Fed pause. A hike in June could be problematic politically if it is seen to have been done in anticipation of fiscal stimulus. Trump and a number of Republican Congressmen already are dubious about the need for Fed independence, and they could view a June hike as politically motivated to thwart Trump's policies. As a result, Fed officials may require solid support from the data and markets if they are to hike. Based on this thought process, it is conceivable that the next Fed hike will be in December.
Yellen will probably be asked questions about fiscal policy at her monetary policy testimony. She will likely say that the economic boost from any fiscal stimulus will depend on the composition of the policy, similar to the ideas expressed in a recent speech by Fed Governor Brainard. She also may repeat that the desired amount of the fiscal stimulus, with its attendant expansion of the Federal deficit, should be evaluated in light of the fact that the economy is now operating close to full employment. This word of caution would argue for a smaller fiscal package than Trump has proposed. It could weigh on the stock market somewhat, but not by enough to derail the rally.
Friday, February 3, 2017
January Employment Report Raises Possibility of Strong Non-Inflationary Growth
The January Employment Report is bullish for stocks and Treasuries -- the report confirms a strong start for the economy in Q117 but one that is accommodated by an increase in labor market participation and is accompanied by low wage inflation. This combination raises the possibility that the supply side of the economy will expand to accommodate stronger GDP Growth in a non-inflationary way. It should keep the Fed on its gradual path of tightening -- if it tightens at all, but more on this in my next blog -- and almost assures that Yellen's Semi-Annual Monetary Policy Testimony (on February 14-15) will be benign.
The +227k m/m increase in January Payrolls looks to have been helped to some extent by the good weather (Construction, +36k, Real Estate Agents +12k) as well as by possibly other one-off factors (Retail Trade, +46k with less firing of holiday-related workers after less-than-normal hiring in Q416). But, the underlying pace is still strong after taking these temporary boosts into account.
The strong underlying pace should not be a problem for the Fed, given the uptick in Unemployment Rate to 4.8% from 4.7% in December. An increase in the Labor Force Participation Rate was responsible. While m/m changes in the Participation Rate could result from changes in the sample, as it stands the uptick raises the possibility that the sharp improvement in consumer sentiment since the election will bring more people back into the jobs market and thus allow for stronger trend GDP growth.
Meanwhile, the low 0.1% m/m increase in Average Hourly Earnings joins other recent data suggesting that wage inflation is well under control (see table below). Note that the small increase was on the low side of calendar considerations for this month. Along with the disinflationary implications of the stronger dollar, the inflation outlook looks benign.
AHE Employment Cost Index Compensation/Hour
(12-month (Q4/Q4 % change) (Q4/Q4 % change)
% change)
Jan 2017 2.5
2016 2.8 2.2 2.9
2015 2.5 2.0 3.1
The +227k m/m increase in January Payrolls looks to have been helped to some extent by the good weather (Construction, +36k, Real Estate Agents +12k) as well as by possibly other one-off factors (Retail Trade, +46k with less firing of holiday-related workers after less-than-normal hiring in Q416). But, the underlying pace is still strong after taking these temporary boosts into account.
The strong underlying pace should not be a problem for the Fed, given the uptick in Unemployment Rate to 4.8% from 4.7% in December. An increase in the Labor Force Participation Rate was responsible. While m/m changes in the Participation Rate could result from changes in the sample, as it stands the uptick raises the possibility that the sharp improvement in consumer sentiment since the election will bring more people back into the jobs market and thus allow for stronger trend GDP growth.
Meanwhile, the low 0.1% m/m increase in Average Hourly Earnings joins other recent data suggesting that wage inflation is well under control (see table below). Note that the small increase was on the low side of calendar considerations for this month. Along with the disinflationary implications of the stronger dollar, the inflation outlook looks benign.
AHE Employment Cost Index Compensation/Hour
(12-month (Q4/Q4 % change) (Q4/Q4 % change)
% change)
Jan 2017 2.5
2016 2.8 2.2 2.9
2015 2.5 2.0 3.1
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