The Fed is Now A Friend to the Markets

The stock market will likely continue to rally into April, as fear of an aggressive Fed has been squashed for now and expectations of Q118 corporate earnings are very high.  The Treasury market also should be buoyed by a "gradual" Fed and, possibly, by neutral to friendly inflation data.

The markets' newfound positive view of the Fed should be reinforced by Fed Chair Powell's Semi-Annual Monetary Policy Testimony on February 27 (House Committee) and March 1 (Senate Committee).  This testimony typically reflects the consensus view at the January FOMC meeting.  And, the "dovish" consensus of a continuing gradual approach to policy tightening was reiterated in the already released written portion of the Testimony.   (In fact, there was nothing new in it.)  Powell's prior support for an easing in bank regulations may come up in the Q & A, as well --  a positive for stocks.

By maintaining its gradual approach to tightening, the Fed is implicitly not pushing for an aggressive "crowding out" of fiscal stimulus.  This implicit acquiescence of fiscal stimulus should hold down the markets' tendency to fight against the stimulus.  It means that 3 upcoming "market events" will not likely cause a problem -- the March 20-21 FOMC Meeting, upcoming inflation data, and Q218 corporate earnings.

The Fed is not likely to change its course a few weeks after talking it up in front of Congress.  So, even if the Fed hikes the funds rate by 25 BPs at the March FOMC Meeting, the Statement will likely maintain a gradual approach tone.  It is even conceivable that the "dots" will still show the FOMC consensus of 3 rate hikes in 2018.  To be sure, a 25 BP is highly likely, unless the February Employment Report and February Core CPI are very weak.

A consensus-like high January Core PCE Deflator will probably be taken in stride, since Fed officials do not seem to have been moved by the high January CPI print.  Consensus looks for a 0.3% m/m Core PCE Deflator, the same as the Core CPI.  But, even with that relatively high print, the y/y would be steady at 1.5% -- staying below the Fed's 2.0% target.  Some of the m/m speedup could be viewed as temporary, as well.  Indeed, an unwinding of the high January Average Hourly Earnings is the risk in the February Employment Report, due March 9 -- a potentially significant positive for stocks and Treasuries.

Third, expectations of Q118 Corporate Earnings, due in April, are quite high.  The Thompson/Reuters survey puts consensus expectations at a whopping 17.9% (y/y) for S&P 500 earnings, after a strong 14.8% in Q417.  Moreover, consensus looks for corporate earnings to get even stronger, at 19.3-21.3%, in Q2 and Q318, respectively.  Stocks are not likely to sell off ahead of these corporate reports, and may very well rally in March in anticipation of them.