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.
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