Wednesday, December 14, 2016

Markets Adjusting for Rate Hike and Yellen's Hawkish Press Conference

Today's quarter-point increase in the Fed Funds rate came as no surprise to anyone.  What followed, however, was the most hawkish press conference Fed Chair Janet Yellen has delivered in her brief tenure.  The official FOMC Press Release was issued at 14:00 EST.  As expected, the release cites continued strength in the labor market as well as moderate expansion in the overall economy. 
The Fed expects inflation to continue to rise gradually towards their 2% target: "Inflation is expected to rise to 2 percent over the medium term as the transitory effects of past declines in energy and import prices dissipate and the labor market strengthens further."  Remember that, in Fed Speak, "medium term" is defined as between two and six years.

It's important to note that today's vote to increase rates was unanimous. Up until this point, there were at least three staunch doves voting against any rate hikes.  That it was unanimous signals a shift in the overall tenor of the committee and may be a harbinger of a more aggressive monetary policy going forward.

The significant change in today's policy announcement comes in the forecast for additional rate increases over the next three years.  Prior to today's announcement, the market was anticipating two quarter-point interest rate hikes in 2017.  The signal today, however, is for three.  Now, Ms. Yellen did caution that not all members are on board with that projection.  As a result, we can anticipate more volatility than usual around the monthly key data releases since the market will need to assess how the FOMC members will interpret the data and how that will influence a potential rate hike in March.  We're likely back into a "good news is bad" scenario where positive economic data creates a selloff out of fears of an additional rate hike.

In her post-announcement press conference, Ms. Yellen acknowledged some of the challenges facing the job market while issuing a veiled caution that the political rhetoric may not match the actual causes.  She specifically mentioned increased technology and automation as significant factors in workforce reduction saying, "For decades the pace of technological change in manufacturing has outstripped that of the economy as a whole. So manufacturing firms have found it easier to continue producing by reducing their work forces."  In other words, the problem is not all due to outsourcing and bad trade deals. Changes in the overall technical infrastructure are major contributing factors, and this rapid rate of change will be a fact of life for the foreseeable future.

On several occasions, the questions offered ample opportunity to opine on the President-Elect and the policies of the incoming administration.  To her credit, the Fed Chair refused to take the bait.  Specific to Mr. Trump's statement that he would not reappoint her, she offered, "I do intend to serve out my four-year term. I haven't made any decision about the future. I recognize I might or might not be reappointed. It's a decision I don't have to make and don't have thoughts on at this time."

 She took the opportunity to repeat several times that the independence of the Fed is a concept with which she fully agrees, and also pointed out that the 4 year term of the Fed Chair is not coterminous with the 4 year Presidential Term.  She made it a point of saying that it was setup this way for a reason, and that it was a very solid practice that has served the nation well.

When pressed on the stock market, she stated, “We’re operating under a cloud of uncertainty at the moment.” Her comments were an acknowledgement that the interpretation of the post-election surge in stock prices represented an expectation of lower corporate taxes, lower regulations, and an overall business friendly environment.  That's the popular interpretation of what we're seeing, however it's not an interpretation I share.  Rather, I believe we're seeing the natural market reaction to the resolution of uncertainty - i.e. the extremely contentious US presidential election - coupled with growing consumer confidence heading to the period of a traditional Santa Claus Rally.  In my view, the post-election surge we're seeing would have occurred regardless of the winner.  It's doubtful that there is this much movement based on the anticipation of what Congress will end up doing with taxes and regulations following at least a full year of debate. 

One factor that the market will weigh over the coming weeks is the impact of the new Fed projections for interest rate targets through 2018.  Both years are now tracking higher in projections than they were a day ago. The median projection for 2017 is now 1.375% (up from 1.155%) and 2018 saw a similar increase to 2.125%.  The target for 2019 is 3.00%. 

Interestingly, Ms. Yellen's opening statement made no mention of the global economic environment.  That comes as a bit of surprise on the heels of Mario Draghi's statements in last week's ECB announcement, coupled with the specter of the potential Article 50 Brexit invocation in the first half of 2017.  Her only mention of the historically low comparable price of oil was in the context of it being transitory: "As the transitory influences of earlier declines in energy prices and prices of imports continue to fade, and as the job market strengthens further, we expect overall inflation to rise to 2 percent over the next couple of years."

All three US major stock indexes retreated following Ms. Yellen's press conference.  We can expect to see a bit of volatility over the next few days as the market digests what FOMC has forecast for the coming year.  In addition, be ever mindful of the stock market truism, "buy the election; sell the inauguration."  Of course, volatility provides excellent short-term trading opportunities, so we'll be closely watching what develops as we head into the end of the year.

Happy Trading

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