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.