The FOMC Meeting Holds Key to Near-Term Stock Market Stabilization

Some technicians look for the stock market to fall another 20-30% in the coming year.   Given the risks of bad outcomes from the US/China trade negotiations and Democratic opposition to Trump in Congress, such a dire prediction cannot be ruled out.  However, the outcome of the December 18-19 FOMC Meeting may hold the key to a near-term stabilization of the stock market -- but its message must be just right.  The Fed needs to be seen as a steady and judicious hand in a confusing and risky environment.  And, the details of the forward guidance cannot be bearish on the economy.

The best result would be if Fed officials stick close to market expectations.  They should hike the funds rate by 25 BPs and state that, because of increased uncertainty surrounding the economic outlook, monetary policy will be flexible so as to respond in the appropriate way to how real growth and inflation evolve.  And, with all the recent talk by Fed officials of a lower-than-thought neutral funds rate, the Central Tendency for the funds rate should be cut to imply 2 hikes in 2019 and 0 hikes in 2020 and 2021.  However, they also should not change their Central Tendency forecasts of the economy or inflation, sending the message that officials still see solid growth and near-2.0% inflation next year. 

                                           Fed's September Central Tendencies
                                          2018           2019          2020          2021
 Real GDP Growth            3.0-3.2        2.4-2.7       1.8-2.1       1.6-2.0

Unemployment Rate        3.7               3.4-3.6       3.4-3.8       3.5-4.0       

PCE Deflator                    2.0-2.1         2.0-2.1      2.1-2.2        2.0-2.2

Core PCE Deflator            1.9-2.0        2.0-2.1      2.1-2.2        2.0-2.2

Fed Funds Rate                 2.1-2.4        2.9-3.4      3.1-3.6        2.9-3.6

Note:  Real GDP Growth and PCE Deflators are Q4/Q4 percent change.  Unemployment Rate is Q4 average.

In contrast, if Fed officials downshift their Real GDP growth forecasts or just push rate hikes into the future, the stock market reaction will likely be negative.  Lowering the GDP forecast would throw doubt on the wisdom of the 25 BP rate hike at the December meeting.  It also would add to market concerns of weaker corporate profits ahead.

The stock market's woes will not necessarily disappear if the FOMC Meeting succeeds in sending a calming message.  Besides continuing risks surrounding US/China trade and Congress Versus Trump, the data dependency of Fed policy could impart further market volatility next year, as market participants guess at the policy implications of strong or weak data prints.  To be sure, Fed officials will not likely react to any individual data release, but wait to see a trend before acting.   There is still a good chance Fed policy will be on hold in H119, as I discussed last week.

This week's US key economic data -- November CPI and Retail Sales -- should have little, if any, influence on the FOMC Meeting's outcome.  Consensus estimates of +0.2% m/m Core CPI and (strong) +0.7% m/m Ex Auto Retail Sales would just confirm expectations of a 25 BP hike at the meeting.  Weaker prints should not derail a hike.